Memorandum Regarding Trust Administration
I. INTRODUCTION
Most individuals have limited experience with trusts and often have many questions upon becoming a trustee for the first time. The purpose of this memo is to try to anticipate your questions by providing a general overview of how trusts work and your duties and responsibilities as a trustee.
Through our experience in helping people administer trusts, we have found that many individuals have unrealistic expectations concerning the way living trusts operate following a death. It is true that a living trust, in many cases, drastically reduces the costs and delays involved in passing on assets at death. A living trust accomplishes this feat by avoiding probate.
However, even without probate, several administrative tasks still need to be completed, legal documents prepared, tax returns filed, and other matters that take time and cost money.
II. TRUSTS IN GENERAL
A. What is a Trust?
A trust is a legal relationship, usually evidenced by a written document called a “Declaration of Trust” or “Trust Agreement,” whereby one person, called the “Settlor,” transfers property to another person, called the “Trustee,” who holds the property for the benefit of another person, called the “Beneficiary.” The same person may occupy more than one position at a time. For example, in the typical living trust, as long as the Settlor is alive, the Settlor is also the Trustee and Beneficiary. On the death of the Settlor, a “Successor Trustee” (e.g., child, friend, bank) takes over as Trustee and follows the Settlor’s instructions, which are set forth in the Trust, concerning the distribution of property and the payment of taxes and expenses.
B. Living Trusts and Probate Avoidance
Although living trusts have been around for centuries, only recently have they achieved a high degree of popularity among the general public. The reason for this surge in popularity is that living trusts help to avoid probate. You might be wondering, “What is probate, and why is everyone trying so hard to avoid it?” The short answer is that probate is a court-supervised procedure for collecting a deceased person’s assets, paying debts and taxes, and distributing the property to the person’s beneficiaries (either according to the instructions the person set forth in the person’s will or as determined by state law if the person died without a will). The probate process usually takes 6 to 12 months to complete, although it may take longer in complicated cases.
Probate is not a tax. When people refer to the high costs of probate, they are usually referring to the fees paid to attorneys and the personal representative. In California, these fees are calculated as a percentage of the gross (not net) value of the assets in the estate. These rates are set out in Probate Code §§10800 and 10810 (4 percent on the first $100,000, 3 percent on the next $100,000, 2 percent on the next $800,000, and so on). For example, let’s say that D, who is not married, dies owning one asset, a house worth $200,000 with a mortgage of $120,000. D has a will that leaves the house to D’s two children, A and B. A is named as executor. The probate fees for this case would be as follows: $7,000 to A’s attorney (plus any “extraordinary fees,” which are billed hourly but subject to court approval) and $7,000 to A (if A decides to take a fee), for a minimum total fee of $14,000. These fees are calculated without regard to the $120,000 mortgage, because the fees are charged on the gross (not net) value of the estate.
One of the reasons living trusts have become so popular in the last 20 years is that real estate prices in California have skyrocketed, leading to much larger estates and, hence, higher probate fees. In states where real estate prices are lower or where attorney fees for probate work are based on an hourly fee schedule rather than a percentage scale, living trusts are less popular than in California.
Living trusts avoid probate with respect to those assets that are transferred into the living trust before death. In other words, living trusts avoid the court procedure otherwise required to transfer assets to a person’s beneficiaries at death. However, as we explain below, even though no court procedure is involved, that does not mean there is nothing to do. The living trust makes administration easier, but it does not do away with administration altogether. For example, assets still have to be collected and managed pending distribution to the beneficiaries, appraisals of assets have to be made, debts and taxes have to be paid, tax returns may be required (living trusts do not avoid estate taxes, as some people have been led to believe), and legal documents must be prepared in connection with the distribution of the trust property to the beneficiaries. These activities are very similar to a probate. The major difference is that, with a living trust, everything is handled privately, without court supervision, which makes for (in most cases) a faster, less expensive administration process.
Although this may come as a surprise, you should realize that post-death administration of a living trust will take time and cost money, such as legal fees, accounting fees, asset transfer fees, and your own Trustee fees if you decide to accept any. The other beneficiaries of the Trust, if any, will also need to understand that the process may take longer than they anticipated. However, in comparison to probate, these delays and cost savings are substantially reduced, often resulting in time savings of months and cost savings of 50 to 90 percent.
C. Court Involvement
There is also a popular misconception that the existence of a living trust avoids all possibility of court involvement. This is true (in part) only if all of the Settlor’s assets were properly funded into the living trust. For example, if assets held outside the trust exceed $184,500 in gross value, a probate will be required for those assets in order for you, as Trustee, to collect those assets and add them to the trust.
Moreover, if at any time a beneficiary of the Trust believes that the Trustee has acted improperly or without regard for the beneficiary’s interests, the beneficiary may file a petition with the court to force the Trustee to make a full report and accounting or to redress an alleged breach of trust, including removal of the Trustee or surcharge against the Trustee.
Finally, circumstances may arise in which there are questions about whether the Trustee should or should not take certain actions (e.g., selling a business interest or real property, commencing litigation). In such cases, it may be advisable for the Trustee to petition the court for instructions on whether to proceed in a certain way. The beneficiaries will be given notice of the hearing and will be given a copy of the petition that describes the proposed action. The matter will then be addressed in open court, and the beneficiaries will have an opportunity to appear and be heard. By obtaining an order from the court in this manner, the Trustee may be able to cut off the beneficiary’s right to complain about the particular action if the beneficiary fails to appear in court. Such a petition protects the Trustee if there is a fear that the Trustee’s decision will be second-guessed by a beneficiary. Also, if relations between the Trustee and the beneficiaries are hostile, it may be advisable for the Trustee to seek court approval of the Trustee’s accountings to minimize potential arguments with the beneficiaries.
III. ADMINISTRATION OF THE FAMILY TRUST
After the Settlor’s death, the Trust continues as a management and distribution vehicle that will exist only as long as is necessary to identify and collect trust assets, pay debts and taxes, and distribute the trust assets to the beneficiaries (or in further trust, depending on the terms of the Trust). You might visualize this trust as a mechanism through which all of the trust assets will pass to the beneficiaries (with the exceptions of tangible personal property, life insurance proceeds, and other non-trust assets that may pass directly to the beneficiaries outside the Trust). As successor Trustee, it is your job to collect and manage the trust’s assets, appraise trust property, pay all taxes and expenses relating to the administration of the Trust, and distribute the trust property according to the Settlor’s instructions.
IV. POUROVER WILLS
In addition to the Trust, the Settlor signed what we call a “pourover” will. The purpose of the pourover will is to provide for the distribution of assets that were omitted from the Trust, either intentionally or inadvertently. One of your first tasks will be to determine what assets, if any, were omitted from the Trust. If any such assets exceed $150,000 in gross value, a probate may be required to transfer these assets to the Trust. If these assets do not exceed $150,000 in value, you can collect such assets under a declaration procedure authorized by the Probate Code. At least 40 days must elapse after the date of death before you can use this declaration procedure. Whether or not a probate is required, the original will must be deposited for safe keeping with the County Clerk within 30 days of the date of death.
V. DISTRIBUTIONS OF PROPERTY
A. Tangible Personal Property
Provided the beneficiaries are in agreement, the distribution of tangible personal property may be handled informally and we need not get involved. If any disagreement develops, however, the division of personal property should be handled in a more formal manner. We recommend that you carefully document and inventory the items of property available for distribution and the disposition of each. One way to document the property on hand is to videotape or photograph the household property before distribution.
Before allowing the distribution of any items of personal property, however, please be aware that you are responsible for reporting such items on a federal estate tax return, if required. Furthermore, if any items of property (or group of items that constitutes a single collection) have a fair market value of $3,000 or more, these items must be separately appraised for federal estate tax purposes. You should therefore keep careful records of what assets are distributed and to whom, and you should obtain any required appraisals before distributing particularly valuable items.
B. Other Distributions From the Trust
One of the first questions the Trustee and other beneficiaries usually ask us is, “When will the trust property be distributed?” Many people, having heard that living trusts avoid probate, assume that all estate administration procedures are avoided and that the property in the living trust somehow passes to them automatically. Having read this far, you now understand that this simply is not true. As a result of this misunderstanding, many beneficiaries are disappointed to learn that the trust administration process is often measured in weeks or months (and in some cases longer), rather than in hours or days.
In answer to the question of when distribution will take place, we anticipate that distribution will take place in several stages. Depending on how quickly assets and liability information can be assembled, you may be able to make preliminary distributions of a portion of the trust estate within a few weeks. After we have obtained all appraisals and can project the expected tax liabilities and expenses with more accuracy, you may distribute more of the trust estate, making certain to reserve sufficient funds for payment of estate taxes, income taxes, administrative expenses, attorney and trustee fees, debts and liabilities, etc. However, if any litigation arises concerning the Trust (e.g., a “contest” of the Trust), you may have to withhold distribution until such problems have been completely resolved.
VI. TRUSTEE DUTIES, POWERS, AND COMPENSATION
A. Standard of Trust Management
As Trustee, you will act in a fiduciary capacity. As such, you owe certain legal duties to the beneficiaries, as explained in more detail below. In managing the trust property, you must use at least ordinary business ability. However, if you have special skills, under California law, you will be held to a higher standard of care. In any event, your management will be judged in light of the circumstances existing at the time transactions occur, rather than with the benefit of hindsight. If you exceed your trustee powers, you may be held liable for loss or damage to the trust estate.