Investment and Distribution Trustees: Why Would I Need Both?

When creating a trust, it is common to name yourself as the initial trustee responsible for administering it. However, when considering who will take over when you can no longer act (either because of illness or death), it is sometimes helpful to divide the responsibilities between two or more successor trustees. For example, you may decide to have one trustee who manages the accounts and property held by the trust and another trustee who makes decisions about distributions to the trust's beneficiaries. There are some essential reasons why you may want your trust document to bifurcate the trustees' duties in this way.

Benefit from specialized knowledge or aptitudes. Trustees have a variety of duties and responsibilities in administering a trust, and it is sometimes beneficial to bifurcate them between more than one trustee based on the expertise or skills needed to perform a particular aspect of the trust's administration. For example, suppose your sister-in-law is knowledgeable about investments and experienced in making financial decisions but is not as skilled at handling potentially tricky interpersonal interactions. In that case, it may be beneficial to name her your investment trustee, whose sole duty is to make discretionary decisions about the investment of funds held by the trust.

Some trusts call for distributions to be made to beneficiaries at the trustee's discretion rather than mandatory distributions of a certain amount or percentage at specific times. For trusts that provide for discretionary distributions, it may be helpful for another trusted person capable of making impartial decisions, skilled at communicating with others, and familiar with the beneficiaries of the trust and their needs to be named the distribution trustee, which is a trustee responsible for making decisions about whether and when to accumulate or distribute the income or principal of the trust.

A trust that bifurcates of trustee responsibilities and duties is beneficial if there are any problematic relationships or potential conflicts between beneficiaries or between one of the trustees and a beneficiary. For example, if your second wife is one of the trustees but the trust's beneficiaries are your children from your first marriage, naming an unrelated third party as the distribution trustee may avoid hard feelings or the perception of unfairness related to distributions. Although it may be more expensive to have two or more trustees instead of a single trustee, the additional expense may be worthwhile to maintain family harmony and avoid damaging relationships.

Gain additional asset protection. Most creditors may not reach a beneficiary's interest in a trust if the trustee is not required to make distributions. Some creditors may be limited in how much they can reach if distributions are based on an ascertainable standard, such as for the beneficiary's health, education, maintenance, and support (HEMS). Depending on state law, this may be true even if the beneficiary is also the sole trustee.

However, the general rule is that the less control a beneficiary has over the trust's accounts and property, the more protection is provided against creditors' claims. Even if the trust beneficiary is the investment trustee, more excellent asset protection may be available if a separate distribution trustee is appointed and empowered to distribute to the beneficiary at their sole discretion. In some jurisdictions, the trust could also provide that the beneficiary could resign as a trustee and appoint another independent trustee to take their place. This might further enhance the level of asset protection if the beneficiary is concerned that they may become more vulnerable to creditors' claims in the future.

Note: This asset protection is typically unavailable for specific creditor claims, such as child support alimony or tax debts. The list of "exception creditors" varies by state and should be discussed with your estate planning attorney.

Minimize taxes. When a trustee has total discretion to make distributions from the trust to themselves or others, the value of the trust's accounts and property may be included in the trustee's estate for estate tax purposes, or the trustee may be taxed on the trust income under Internal Revenue Code (I.R.C.) § 678. Depending on the type of trust and the goals it is designed to achieve, an independent trustee could be appointed to minimize either estate or income taxes.

Example: To avoid having the property held by the trust included in their estate for estate tax purposes, the terms of the trust may permit a trustee who is also a beneficiary to select an independent distribution trustee as long as that distribution trustee is independent—not a related party or a person subordinate to the beneficiary as defined by I.R.C. § 672(c). In this situation, the investment trustee, who is also a beneficiary, will not have direct control over the amount or timing of the distributions. However, they may still retain significant control over who serves as the independent co-trustee. In addition to choosing the independent distribution trustee, the trust document may provide that the beneficiary can replace the independent trustee at any time and for any reason.

Example: If your trust is a nongrantor trust—i.e., a trust that is a separate entity for tax purposes that pays taxes on trust income at the trust level—it is essential for someone other than the grantor (the person who creates the trust) or any party who is related or subordinate to them to be the investment trustee. This is because the power to determine trust investments may be considered the power to control the beneficial enjoyment of the trust assets under I.R.C. § 674, meaning the grantor, rather than the trust, must pay taxes on the trust income. 

Book a Call

If you would like to find out more about whether you should bifurcate the investment and distribution duties of your trustees, book a call. Although having more than one trustee will make the trust more complex, and additional fees may be required for the services the trustees provide, you may decide that the benefits far outweigh any additional costs. We can help you design your trust to best achieve your goals by maintaining family harmony, protecting assets, and minimizing taxes.