Section 7A: Trustee Selection

This chapter examines factors that a grantor should consider in the selecting a trustee for the ILIT, including trustee attributes, duties and liabilities.1 The chapter also contains a discussion of the non-insured surviving spouse serving as a trustee of the ILIT.

7A.1 SELECTION OF TRUSTEE

In selecting a trustee to administer the ILIT and its subsequent resulting trusts, such as a marital deduction trust and a family (i.e., credit shelter) trust, the grantor needs to consider a myriad of tax and non-tax factors. Because a trust may be in existence for years, if not decades, flexibility concerning successor trustees and co-trustees also needs to be considered. In this regard, the trust instrument should permit an individual trustee to appoint a substitute trustee or co-trustee for property or matters that the individual trustee is unable to handle. See, Paragraphs 6.5 and 6.6 of Sample ILIT. Additional flexibility can be achieved by permitting current individual trustees to name their own successors, subject to certain limitations. See, Paragraph 6.7 of Sample ILIT. The most significant form of flexibility regarding trustee matters is the ability of the grantor or a beneficiary to remove a trustee and appoint a successor trustee. See, Paragraph 6.21 of Sample ILIT.

7.1(a) Power To Remove And Replace Trustee

If a beneficiary has the unrestricted right to remove a trustee and can appoint himself or herself or a related or subordinate person (with- in the meaning of IRC section 672(c)) as successor trustee, that beneficiary will be deemed to possess the powers of the trustee, which may result in the beneficiary having a general power of appointment over the trust estate under IRC section 2041. Treas. Reg. §20.2041-1(b). If, however, the beneficiary’s power to remove and replace the trustee is limited to appointing someone who is not related or subordinate to the beneficiary, such as an independent trustee or corporate trustee, then the beneficiary is not considered as having a general power of appointment over the trust estate. Rev. Rul. 95-58, 1995-2 C.B. 191; Priv. Letter Rul. 9607008. See, Paragraph 8.3(I) of Sample ILIT for a comprehensive definition of an independent trustee. A beneficiary can also be given the power to remove a trustee for reasonable cause, in which case the beneficiary is not bound by the requirements of Rev. Rul. 95- 58, and can appoint anyone as the successor trustee. See, Paragraph 6.21(A) of Sample ILIT permitting the appointment of a disinterest- ed trustee (as defined in Paragraph 8.3(K) of Sample ILIT). See Chapter 8, above, for a discussion of the tax consequences of a beneficiary who serves as trustee.

7A.2 TRUSTEE DUTIES

In selecting a trustee to administer the ILIT and its subsequent resulting trusts, the grantor should be mindful of a trustee’s duties.2 Duties may be imposed by statute, common law, and the trust instrument. Many, but not all, of the duties imposed by law can be modified by the trust instrument. The paramount duty of a trustee, which underlies all other duties, is his or her fiduciary duty. The trustee stands in a fiduciary relationship with the trust and its beneficiaries. This relationship involves a duty on the part of the trustee to act for the benefit of the trust beneficiaries, and to administer the trust solely in the interest of the trust beneficiaries (and not for the trustee’s own benefit). A corporate fiduciary is familiar and experienced in trust matters; however, few individuals, especially family members, have sufficient experience and expertise to administer a trust on their own. Consequently, the individual trustee will need legal, accounting, investment and tax assistance in fulfilling his or her duties.3 Thus, there will be additional expenses when an individual serves as the sole trustee. If the individual trustee desires the assistance of a co-trustee, the trust instrument can permit the appointment of a co-trustee, including a corporate trustee, by the individual trustee. See, Paragraph 6.5 of Sample ILIT.

The typical duties of a trustee include:

7A.2(a) Duty To Administer The Trust

Once a person has accepted the appointment as a trustee, that person must administer the trust according to its terms as long as that person serves as a trustee—even if that person receives no compensation for serving as a trustee. When the trust contains ambiguous or uncertain terms, the trustee will need professional assistance, and possible judicial interpretation of the trust instrument. A trustee may not resign unless permitted by the terms of the trust, by consent of the beneficiaries, or by a court. See, Paragraph 6.3 of Sample ILIT.

7A.2(b) Duty Of Loyalty To The Trust And Its Beneficiaries

The trustee has the duty to administer the trust solely in the interests of the beneficiaries, to be honest, to avoid conflicts of interest and self dealing, and to act in good faith. This is the fundamental fiduciary duty of a trustee.

Common examples of potential self dealing include:

  • Sale or lease of property to the trust by the trustee (including the trustee’s own securities);
  • Purchase of trust property by the trustee at public sale or auction;
  • Lease of trust property to the trustee;
  • Loan by the trustee to the trust;
  • Loan by the trust to the trustee;
  • Investment of the trust’s assets in the trustee’s own securities;
  • Employment of agents related to the trustee;
  • Personal use of the trust property by the trustee;
  • Use of the trust property by the trustee for personal profit; and
  • Trustee’s engagement in a business that competes with the trust.

These impermissible forms of self dealing and conflict of interest can be waived by the express terms of the trust, by statute, with the consent of the beneficiaries (after full disclosure by the trustee), or by court approval (after full disclosure by the trustee). See, Paragraphs 6.19, 7.1(A)(2), 7.1(A)(5), and 7.1(A)(10) of Sample ILIT.

7A.2(c) Duty To Administer The Trust With Reasonable Skill And Care

A trustee must administer the trust with same care, skill, and caution as a prudent person would in dealing with his own property. If the trustee has special skills or is named trustee on the basis of representation of special skills or expertise, the trustee is under a duty to use those skills. See, Paragraph 6.18 of Sample ILIT.

7A.2(d) Prudent Investor Rule

The trustee has the duty to prudently invest and reinvest trust assets.4 This obligation includes the duty to diversify the trust’s assets and investments to reduce the risk of loss. This duty may be modified by the grantor.5 See, Paragraph 7.1(A)(1) of Sample ILIT. In the ILIT context, this duty is sometimes referred to as trust owned life insurance (“TOLI”) management,6 and may require the trustee to delegate TOLI management to a life insurance specialist, such as a fee only life insurance advisor.

7A.2(e) Duty To Give Notices, Furnish Information, And Communicate With The Trust Beneficiaries

The trustee has the duty to keep the beneficiaries of a trust reasonably informed of the trust and its administration. This will require the trustee to give notices, furnish information, and communicate with the trust beneficiaries. This duty corresponds with the duty to account. It also corresponds with the duty to monitor a trust beneficiary’s need to determine if distributions should be made to that beneficiary, and to determine if a beneficiary’s interest in the trust has terminated (e.g., the beneficiary has reached a specified age and is no longer entitled to trust distributions, or the beneficiary has died). See, Paragraph 6.20 of Sample ILIT.

7A.2(f) Duty To Collect, Control, And Use Reasonable Care And Skill To Preserve And Protect, Trust Property

 This duty corresponds with the duty to prudently invest the trust property.

7A.2(g) Duty To Account To The Beneficiaries

 This duty may be modified by the grantor, but not eliminated. See, Paragraph 7.9 of Sample ILIT.

7A.2(h) Duty To Keep Accurate Records

A trustee must keep clear and accurate records of the trust’s administration. This will be helpful for preparing annual accountings, requesting reimbursements, etc. See, Paragraph 7.9(B) of Sample ILIT.

7A.2(i) Duty To Identify And Separate Trust Property

The trustee has the duty to identify trust property, and to not commingle trust property with the trustee’s own property, or with the property of other trusts.

7A.2(j) Duty To Enforce Trust Claims

The trustee has the duty to enforce claims of the trust (including claims against any predecessor trustee or executor), and to defend the trust against adverse claims that may result in a loss to the trust estate.

7A.2(k) Duty To Make Decisions Concerning Discretionary Distributions

The trustee has a duty to determine whether discretionary distributions should be made, and under what circumstances.7 This corresponds with the duty to participate in the administration of the trust, and the duty not to delegate.

7A.2(l) Duty To Uphold And Defend The Trust

 The trustee has the duty to uphold and defend the trust according to its terms and the grantor’s intent.

7A.2(m) Duty To Participate In The Administration Of The Trust

The trustee has the duty to participate in the administration of the trust with the other co-trustees, and to prevent a breach of trust by another co-trustee; and if necessary, to compel a co-trustee to redress a breach of trust.

7A.2(n) Duty Of Impartiality

The trustee has the duty to treat beneficiaries impartially and fairly, both individually and by class, and to balance the competing and conflicting interest of the beneficiaries, such as the income beneficiaries and the remainder beneficiaries, and multiple beneficiaries in the same class.8 As part of the duty of impartiality, the trustee must con-sider the interests and the needs of all the trust beneficiaries when making investment decisions.

7A.2(o) Duty To Make Property Productive

The trustee has the duty to use reasonable care and skill to make the trust property productive. This duty corresponds with the duty to prudently invest the trust property, and may be modified by the grantor.

7A.2(p) Duty Not To Delegate

The trustee has the duty to give personal attention to the trust, and to not delegate to others the performance of any acts the trustee can reasonably be expected to perform personally, such as acts involving the exercise of judgment and discretion.

The Uniform Prudent Investor Act permits a trustee to delegate investment and management functions as is prudent under the circumstances.9 As previously mentioned, it may be prudent for an ILIT trustee who lacks the expertise to manage TOLI, to delegate that function to a specialist. See, section 9.2(d), above.

7A.2(q) Duty To Determine Principal And Income, And To Pay Income

 The trustee has the duty to separate income from principal, and to pay income to the income beneficiaries at reasonable intervals. See, Paragraphs 7.1(A)(9) and (13) of Sample ILIT.

7A.2(r) Duty Of Confidentiality

The trustee has the duty to keep the affairs of the trust and its beneficiaries confidential, unless otherwise required by law or permitted by the trust instrument. This duty applies to the identity and interests of the beneficiaries, the terms of the trust, and the nature of the trust’s assets.

7A.2(s) Duty To Follow Instructions Of Superior Power holder

The trustee has the duty to act in accordance with the proper exercise of a person’s power to control the trustee’s actions, such as following the directions of the grantor (as concerns a revocable trust), trust protector, special power holder, or a beneficiary holding a currently exercisable intervivos general power of appointment over the trust assets. See, Paragraphs 4.2 and 8.2(C) of Sample ILIT.

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