Charitable Trust Administration - Part 2

Charitable Trust Administration - Part 2

How an ounce of prevention may provide tons of cure
Article posted in Ethics, Charitable Remainder Trust, Practice on 24 April 2014| comments
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By Randy Fox and Daniel Felix

As we discussed in Part One of this article, philanthropy adds a complex dimension to affluent families’ long-term wealth and tax planning, and we explored the use of charitable remainder trusts (CRTs), charitable lead trusts (CLTs) and fiduciary responsibility.

The great Benjamin Franklin said, “an ounce of prevention is worth a pound of cure.” He meant that anticipating a problem and taking care of it before it happens is often cheaper—and easier—than dealing with the problem down the road. This is not to suggest that every known risk can be anticipated when drafting a charitable trust, but that grantors and drafters should thoroughly discuss and think through as many risks, scenarios and consequences of their plan as possible before finalizing it. They should also incorporate as much flexibility as possible into the plan without losing sight of the ultimate purpose of the trust.

Avoiding trust planning blind spots

Trust administration is too often the blind spot of advanced trust and estate planning. The trust creator (aka the grantor) and his or her attorney may do a fine job of creating a plan, but may sometimes fail to understand that ongoing administration is the key to its success.

Further, advising the trustee “just to follow the document” doesn’t reflect the reality the trustee often faces while trying to care for the trust creator’s most dear assets: the family and its favorite charities. That scenario is understandably beyond the imagination of the trust creator. For example, consider that reasonable jurists disagreed about how the Constitution of the United States should have been administered back when the drafters were still alive, let alone now, in a country facing situations that even Benjamin Franklin couldn’t have imagined.

Satisfying the needs of different, competing beneficiary classes is one of the biggest challenges faced by trust creators. There are known issues when one beneficiary (or an entire class of beneficiaries) has a life interest while another beneficiary (or class) is standing by for the balance. This is the situation in many charitable trusts.

Textbook examples of the challenge of satisfying different beneficiary classes include:

  • Situations in which the trust creators provide their current significant others with a life interest in all or part of the trust, while reserving the balance of the estate to children from a prior relationship;
  • Any division of interest or investment income to one beneficiary while leaving the principal to another. This is a frequent scenario in charitable trusts.

The situation can be deeply aggravated when one of the interested parties—such as a child from a prior marriage or the charity itself—is named to serve as trustee. The appearance of conflict of interest alone is enough to undermine the actions of that trustee, however well-intentioned and honest. And where self-interest understandably pokes through the trustee’s fiduciary role, the trust is now in a position for potential conflict and possible litigation. Given the inherent conflict, it’s no accident that beneficiary class competitions form the basis of many lawsuits.

However, even well-intentioned, disinterested trustees will have difficulty in dealing with this competing beneficiary-class challenge where the trust document has not adequately anticipated the situation. In fact, that trustee may have to hire lawyers and other experts to help modify the trust to make it workable. And that repair process will add to the trust’s expense, especially given the possibility that the repair may require a consensus of the two warring classes.

Solving complicated trust matters

The good news is that new trustee tools—such as decanting and nonjudicial settlement agreements—give trustees in many jurisdictions the flexibility to make these repairs. But the bad news is that these remedies are several pounds of “cure.”

Lawsuits and family division are unsavory results of disputes that don’t get addressed early on. If the family and the charity are truly the most important factors for the trust creator, then the “prevention” should be rolled out ASAP.

Prevention starts in the trust document itself. As with other trust administration issues—indeed, with life in general—planning that anticipates the known challenges can make a significant difference in the long-term success of the trust. No matter how carefully the trust is drafted, unforeseen issues will arise as well.

Planning may not be simple. There may be highly sophisticated considerations of state tax, federal tax and trust law with respect to the trust creator’s intentions for the family and the charity. These can be more technical and involved than those otherwise necessary for the trust.

There is also the key question of the trustee’s job: Will this plan really help the trustee—and all the beneficiaries—get out from under the technical problem of the laws?

Generally, the more the trust document can specify, the better. The trust document should spell out what the trustee is to consider and, to an even greater degree, how the trustee is to resolve the competing interests of two or more sets of beneficiaries. This can be accomplished in ways that also meet the other goals of the trust creator and the family.

These instructions to the trustee need to be practical, so we recommend using a professional trustee to review the plan and tell you if or how the trust will fly.

Total return and unitrust approaches

Where available, two other helpful tools of professional planners are (1) Specifying some type of “total return” investment approach and (2) Using the “unitrust” concept to define the income. The total return investment approach attempts to find common ground between income and growth by rewarding the income beneficiaries for growth as well as income according to an agreed formula. The mere adoption of this approach on its own can help align the interests of the two classes of beneficiaries, and so mitigate their competitiveness.

In the total return model, the payment to the family’s life interest can either be at a fixed dollar amount, which is an annuity payment, or fluctuate with the value of the asset. This latter is called a unitrust payment. These concepts are well-defined in the charitable trust environment.

Conclusion

Planning for a successful charitable trust should include consideration of how the total return and unitrust features may fit into the specifics of what a particular family may need.

Next time, we’ll go through a case study of how a very successful and charitable client established a Net Income with Make-up Charitable Remainder Unitrust (NIMCRUT) for his life and the life of his partner, who was 20 years younger.

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