Considerations when Selecting a Successor Trustee

Many clients include a Revocable Living Trust as a core document in their estate plan in order to avoid the costs, delays, and publicity of a formal probate proceeding at their passing. 

While most clients designate themselves as the Trustee of their RLT, it is vitally important to also designate a Successor Trustee, in the event that the client becomes ill, injured, incapacitated, or passes away. Without a Successor Trustee, if one of the above events occur, a member of the client’s family would have to initiate a legal proceeding in order to have a judge appoint a Guardian or Successor Trustee to administer the Trust.

While any competent adult may serve as Trustee, this edition of Estate Planning Matters will examine the factors that a client should consider when naming another individual to serve as Trustee of their Trust.

Designating a Successor Trustee
When selecting an individual to serve as Trustee, the Trustee should be deemed a United States person for income tax purposes. If any of the following are true: a non-U.S. person serves as sole trustee, non-U.S. persons constitute at least half of the trustees, or if a non-U.S. person may make any “substantial decisions,” then according to Treas. Reg. 301.7701-7(d)(1)(ii), the trust will be considered a foreign trust for income tax purposes. 

Generally, foreign trusts have increased reporting requirements for contributions to or distributions from the trust. In addition, the U.S. grantor of the trust needs to file Form 3520, (Annual Return to Report Transactions with Foreign Trusts), and the Trustee needs to file Form 3520-A, (Annual Information Return of Foreign Trust with a U.S. Owner). In addition, Internal Revenue Code (“IRC”) Section 684 triggers gain recognition when no U.S. beneficiaries exist or when the client dies. 

For these reasons, we recommend that our clients designate a U.S. person as trustee, or find a suitable corporate fiduciary to serve as a Successor Trustee. Also note that under some circumstances, naming a trustee who resides in another state may subject the trust to state income taxation if the trustee resides in a state that determines the domicile of the trust based upon the residence of the trustee. Therefore, clients and their estate planning attorney need to consider and analyze state laws when determining who should be designated as a Successor Trustee.

Aside from selecting a U.S. person to serve as trustee, let’s examine some of the important characteristics that a trustee should possess. The word “trustee” contains the word “trust” which provides the first clue about who will make a good trustee: someone the client trusts. 

Serving as a Trustee
An individual serving as trustee will usually need to make numerous decisions throughout the administration of the trust and these decisions require a certain degree of judgment, experience, impartiality, investment sophistication, record-keeping ability, and the ability to avoid conflicts of interest. 

The trustee will need to follow the letter and spirit of both the trust agreement and governing state statutes. These decisions become more complex when tension exists between the beneficiaries. Many clients believe that naming siblings as co-trustees will force the siblings to work together. Often, it has the opposite effect and causes resentment and a situation ripe for fallouts among family members. 

Another common situation involves a trust created for the benefit of a spouse during the surviving spouse’s lifetime with the remainder distributing to children who are not the biological children of the surviving spouse. Giving the trustee power to make distributions of principal for the surviving spouse would reduce the amount passed to the children upon the death of the surviving spouse. 

Therefore, the individual serving as trustee needs to understand specific family dynamics and the potential for family conflict to occur. While some clients often believe their surviving family members will be immune to these behaviors, a well-counseled and wise client understands that these problems occur frequently and plans for them by selecting a suitable individual and/or bank trust department to serve as Successor Trustee.

Once the client has confidence that the proposed Successor Trustee possesses the ability to administer the trust and successfully navigate the process of working with beneficiaries, the trustee then needs to understand the powers that are granted under the terms and provisions of the trust agreement, along with the impact of those powers. 

This begins with the client, in consultation with their estate planning attorney, deciding what distribution standard will guide the Trustee. Giving a trustee absolute, unlimited, or sole discretion puts the trustee in complete control of distributions and makes it more difficult for a beneficiary to compel distributions if the trustee decides not to make specific distributions to the beneficiaries. While this distribution standard provides the highest level of asset protection, it comes at a price. One flexible estate planning option would be to include a power for the trustee to distribute principal and income from the trust for the health, education, maintenance, and support, (also known as the “HEMS” standard) of the beneficiaries.

At The Levin Law Firm, we help guide our clients to establish comprehensive estate plans designed to achieve their wealth transfer planning goals.