Avoid Common Mistakes That Could Lead to Unintentional Violation of Trust Terms

Trusts can benefit your family now and for generations to come. They also can provide significant advantages, including estate tax reduction and creditor protection.

But a trustee's unintentional actions can undo even the most well designed and robust trust documents.

Trust protections

The power of using a trust is that beneficiaries do not own the assets. The trust is the owner and as such, it cannot be seized by beneficiaries' creditors.

As additional protection, many trusts contain parameters, called ascertainable standards, for trustees to follow. This means that the trustee cannot make distributions to the beneficiary for just any reason. Rather, distributions must be related to the "health, education, maintenance and support" of the beneficiary.

If a trustee makes a distribution that could be considered outside of these parameters, the trust corpus (or principal) could be deemed to be property of the beneficiary, compromising the estate tax and asset protections.

Insufficient attention

Consider, for example, a beneficiary who also is the trustee of her own trust. With no one looking over her shoulder to confirm that she is making distributions according to ascertainable standards rules, she invests some trust funds in her college roommate’s startup. She sincerely believes the fledgling business is an amazing opportunity and that the distribution is an allowable investment for the trust's benefit.

However, the business fails and our beneficiary is found to be liable for some of the company’s debt.

A creditor can prove that she exercised her own discretion outside the ascertainable standards and will seek to attach to the trust corpus, arguing that the beneficiary’s personal assets are no longer separate from the trust. The entire trust is at risk.

Other trust threats

While the previous example might be an extreme case, there are many other creditor scenarios that could threaten a trust. Common ones include:

• Divorce. Forty to 50 percent of marriages end in divorce. A former spouse can now be your creditor.
• Accidents. Your teenage son or daughter causes a car accident and the damage is more than your insurance limit. The other driver and passengers can obtain a substantial judgment against you.
• Group decisions. You are an executive at a publicly traded company or a board member for your favorite charity. You may be personally held liable for your or others’ actions and the organization may lack officers and directors insurance.

Easy trust protection steps

How can you avoid potential problems with your trust?

• Require a professional trustee, such as a CPA or trust company. You will avoid personal or familial conflicts and a professional will thoroughly understand the trust document. A professional trustee also will carry errors and omissions insurance in the event of malfeasance or negligence.
• Ensure the trustee maintains detailed records of distributions to the beneficiary, including reasons why the distribution was justified.
• If the beneficiary has been freely accessing the principal, talk to your attorney about options to move the assets out of the tainted trust and into a new one.
• If the trust is involved with the beneficiary's business dealings, make sure any transactions are reviewed thoroughly by third parties to determine whether they are arms-length.

We are always available to discuss any situations that have arisen with your trusts and can refer you to excellent attorneys in your area for advice.