What Advantages Do Directed Trust Statutes Offer?

As originally published in Worth

Appointing a trustee is one of the most critical decisions wealth owners make. Trustees have tremendous in­fluence over the long-term sustainabil­ity of a family’s wealth, and their decisions can affect family dynamics and relations. Grantors often struggle with deciding between appointing an individual trustee they feel fully under­stands their values and will make deci­sions that reflect those values, versus appointing a corporate trustee that can more easily handle the investment and administrative requirements and pro­vide long-term continuity over the life of the trust. Fortunately, a majority of states have adopted statutes providing grantors with greater flexibility and an ability to bifurcate trustee duties among multiple parties.

In states with these “directed trust provisions,” grantors may first select a trustee to oversee decisions on issues like special distributions and interpre­tation of the trust’s intentions, then also appoint a financial institution to invest and manage the trust’s assets. This not only lessens the burden for trustees, it allows grantors to appoint an individual who lacks a technical in­vestment background but is someone they believe will best interpret their intentions in the future. Additionally, directed trust statutes protect trust assets from complacent management by enabling grantors to hire external advisors to invest the assets.

When grantors appoint a corporate trustee in an “old-fashioned” (nondi­rected) trust, one entity, typically a bank, has custody of the assets, pro­vides record-keeping and tax informa­tion and exercises discretionary judgment as to distributions to benefi­ciaries. This institution also manages the assets, typically with its own in-house portfolio managers and internal proprietary products. There is no inde­pendent review or approval of invest­ment decisions—which are often opaque—putting the trust assets at risk of mediocre performance.

Given the high fees that corporate trustees typically charge for these ser­vices, it is a great arrangement for the corporation but not for the beneficia­ries. There is no check-and-balance to the system. It’s also highly unlikely that the corporate trustee will fire itself for poor investment results, and if sued, it only has to prove that the investment performance was not a disaster. In other words, mediocre is acceptable.

With the flexibility a directed trust statute provides, more and more wealthy families are rejecting this type of closed-system arrange­ment. Instead, grantors are naming a bank or large trust company to per­form the administrative functions of a trustee, but separating out the invest­ment responsibilities. Sometimes they’ll name a different firm, or give the power to choose the investment managers to someone outside the bank or trust company.

This arrangement creates healthy competition, which is often to the fam­ily’s benefit. The outside investment advisors’ actions are seen by the cor­porate trustee (which has custody of the assets in most arrangements). Then that corporate trustee is able to point out deficiencies, in hopes of dis­lodging the outsider, to win the in­vestment mandate for itself.

Banks and trust companies gener­ally do not advertise that they are will­ing to act as the trustee without also managing the assets. When asked, some attempt to discourage the prac­tice by quoting a very unattractive price. (Separation of duties is prefera­ble, but not if it’s so expensive that it negates the benefits of better invest­ment performance.) However, as more families learn about the flexibility and benefits di­rected trusts provide, they’re finding that institutions are acquiescing to the growing number of requests for this arrangement.

Whether a grantor is struggling with ensuring that a trust fulfills the intentions for which it was established or simply wants to sleep better at night knowing the trust assets will be effec­tively managed and monitored, the di­rected trust statute provides the flexibility and incentives needed to improve the long-term outcome.

The material shown is for informational purposes only and should not be construed as accounting, legal, or tax advice.  Altair Advisers LLC is a registered investment adviser with the Securities and Exchange Commission; registration does not imply a certain level of skill or training.  While efforts are made to ensure information contained herein is accurate, Altair Advisers cannot guarantee the accuracy of all such information presented.