A trustee is bound by the terms of the trust agreement. The performance of his or her duties, including and especially making distributions to beneficiaries, must strictly comply with the trust terms. However, more and more trusts, especially those utilizing advanced estate, tax, and asset protection planning techniques, provide an independent trustee with sole and absolute discretion to make distributions of principal and/or income to the trusts beneficiaries. So how does a trustee exercise this discretion? Is the trustee free to do anything or are there restrictions?
Even when a trustee holds sole and absolute discretion over trust distributions, the trustee must still exercise that discretion in a reasonable fashion. Specifically, the Trustee must balance the competing purposes of the trust. Specifically the Trustee must weigh his or her responsibility to have assets to distribute against the beneficiaries needs and wants. Satisfying immediate and excessive wants will deplete the trust and render the beneficiary helpless in a moment of greater need. So how does a trustee draw that line?
Hopefully the creator of the trust, known as the Trustor, Grantor, or Settlor, provided the trustee with a non-binding advisory letter describing his or her intent in creating the trust, his or her impressions of the beneficiaries, and his or her opinions on the liberality of discretionary distributions. If so, the trustee should closely consult this letter and do his or her best at following its terms.
If no such letter was provided, the trustee should do his or her best to recreate this information. Conversations with the creator’s advisors, family, and the beneficiaries are prudent; but always maintain your independence and that the information shared is nonbinding and not protected by confidentiality.
Ultimately, whether the information is provided in a letter or obtained through the trustees efforts, at some point a beneficiary will desire a distribution or even a series of distributions. What should the Trustee do then?
The trustee should keep a record of all distributions. Preferably, distribution requests should be in writing, signed by the beneficiary, and state at least the amount and reason for the distribution. The more justification provided for the distribution the better. Some forms of common justification are copies of medical bills, a monthly budget describing income and expenses, or a business or investment proposal.
Distributions intended for pure luxuries, such as a Lamborghini, should be weighed against both the purposes of the trust and the trust’s available resources. For example, if the creator intended liberal distributions but a Lamborghini would force the trust to liquidate income producing assets, it should be avoided. Liquidating income producing assets shortens the trusts lifetime and ability to provide the beneficiary with more important needs at a latter date, such as medical expenses. On the other hand, if the creator intended conservative distributions, even if the income is sufficient to purchase a Lamborghini, the trustee would be better off purchasing a Mercedes, Lexus, or something even more conservative.
The trustee should also actually examine the distribution request, supporting evidence, trust financials and then make a decision. The trustee should not blindly follow the beneficiary’s requests and should avoid routine and periodic trust distributions. These facts may be indicative of an unwritten agreement between the trustee and the beneficiary. This type of unwritten agreement will often cause negative tax and asset protection consequences. For this reason the trustee should not enter into any such agreement and should avoid even the appearance of an agreement.