legal comparisons

Investment vs. Distribution Trustees

Gregory DuPont, JD, CFP June 13, 2023

When creating a trust, many people chose to name themselves as the initial trustee. They want to be responsible for administering the trust until they die. However, there will come a time when someone needs to take over (either because of illness or death). When that time comes, it can be helpful to divide the responsibilities between two or more successor trustees. For example, you may decide to have one trustee manage accounts and property and another trustee handle distributions to beneficiaries.

In this blog, we'll go over the differences between the two and some reasons why you may want to bifurcate your trustees’ duties in this way.

Splitting Trust Duties for Specialized Knowledge

You may want to divide trust duties and responsibilities based on skills or experience. For example, if your sister is knowledgeable about investments and finances, but isn't skilled in handling potentially difficult interpersonal interactions, it may be beneficial to only name her as your investment trustee. An investment trustee's sole duty is to make discretionary decisions about the investment of funds held by the trust.

Some trusts call for distributions to be made to beneficiaries at the trustee's discretion. In these circumstances, it can be helpful for another trusted person capable of making impartial decisions, with communication skills, and whom is familiar with the beneficiaries and their needs, be named distribution trustee. The distribution trustee handles making decisions about whether and when to accumulate or distribute trust funds.

This division of responsibilities is particularly helpful if there are any conflicts between beneficiaries or between one of the trustees and a beneficiary. For example, if your second wife is the trustee of your trust but the beneficiaries are your children from your first marriage. Naming an unrelated third party as distribution trustee may relieve some tension.

Although this may be a more expensive option, the added expense can be worthwhile to maintain family harmony.

Adding a Second Trustee for Asset Protection

In most cases, creditors cannot reach a beneficiary's interest in a trust if the trustee isn't required to make distributions. Some creditors may be limited in how much they can reach if distributions are based on an ascertainable standard such as for the health, education, maintenance, and support (HEMS) of the beneficiary. The general rule is that the less control a beneficiary has over trust assets, the more protection against creditors’ claims.

If the beneficiary of the trust is also the investment trustee, greater asset protection may be available if a separate distribution trustee is appointed. The distribution trustee can be empowered to make distributions to the beneficiary in their discretion.

Note: This asset protection is typically not available for certain creditor claims, such as for child support, alimony or tax debts. The list of “exception creditors” varies by state and should be discussed with your estate planning attorney.

Adding a Second Trustee to Minimize Taxes

When a trustee has total discretion to make distributions to themselves or others, the value of the trust’s accounts and property may be included in the trustee’s estate for estate tax purposes. The trustee could also be taxed on the trust income under Internal Revenue Code (I.R.C.) § 678. Depending on the type of trust and the goals it's designed to achieve, an independent trustee could be appointed to minimize either estate or income taxes.

Example: To avoid having the property in the trust included for estate tax purposes, a trustee who is also a beneficiary may be permitted by the terms of the trust to select an independent distribution trustee. The distribution trustee must actually be independent—not a related party or a person subordinate to the beneficiary as defined by I.R.C. § 672(c). In this situation, the investment trustee, who is also a beneficiary, will not have direct control over the amount or timing of the distributions. But, they may still retain significant control over who serves as the independent co-trustee. In addition to choosing the independent distribution trustee, the trust document may provide that the beneficiary can replace the independent trustee at any time for any reason.

Example: If your trust is a nongrantor trust—i.e., a trust that is a separate entity for tax purposes—it is important for someone other than the grantor (the person who creates the trust) or any party who is related or subordinate to them to be the investment trustee. This is because the power to determine trust investments may be considered to be the power to control the beneficial enjoyment of the trust assets under I.R.C. § 674, which would mean the grantor, rather than the trust, must pay taxes on the trust income.

Contact Our Estate Planning Attorneys to Set Up a Trust

The experienced estate planning attorneys at the Law Offices of DuPont and Blumenstiel are here to help. Whatever your goals are, we can draft a trust that serves your needs. Call our office at 614-408-0529 to set up an appointment.