On my website, I answer consumer questions about all aspects of estate planning. Here are the five most asked questions along with my responses:
How much should the trustee be paid?
This question is asked both by trustees seeking to be paid for their services and by beneficiaries who feel their trustees are overcharging. Trustees are entitled to “reasonable” compensation. But what’s “reasonable?” This can be difficult to answer concretely because so many elements can go into the determination, including:
the trustee’s experience,
the amount of work involved,
the size of the trust,
any agreement between the grantor and the trustee,
prevailing rates in the community where the trust or trust property is located, and
overall costs faced by the trust.
As a guideline, professional trustees — banks, trust companies and attorneys acting as trustee — typically charge between 1.0% and 1.5% of the trust assets each year, a larger percentage for smaller trusts and a lower percentage for larger ones since the work for a $4 million trust is not going to be so much different from that for a $2 million trust.
Nonprofessional trustees can use these percentages as guidelines as well. But they should consider the trust’s overall costs. Professional trustee fees often are all-inclusive, with no extra charges for investment management. If the nonprofessional trustee is using an investment manager that is charging 1.0% of assets under management, the trustee fee should not be another 1.0%. Likewise, if the nonprofessional trustee is paying for a bookkeeper or an attorney to carry out functions generally carried out at no extra charge by a professional trustee, then he or she should discount his or her fee accordingly. On the other hand, professional trustees generally hire outside accountants to prepare trust income tax returns, so that cost should not come out of the trustee’s fee.
Matters get dicey when family-member trustees perform extra services beyond what a professional trustee would normally provide. These typically involve real estate, whether preparing it for sale after the grantor’s death or managing it for rental. Trustees can put in a lot of work and generally should be compensated. However, a number of factors often raise complications. Often trustees throw themselves into the work and don’t think about compensation until after the fact. In that case, it’s difficult for them to receive full payment for their services. They may have created the expectation that they would not get paid. Other family members might have been willing to do the work for no pay or less pay. An outside contractor might have done it better. In these cases, it’s often best for the trustee to take payment that would be significantly less than the trust might have paid a third party. This is also true if the trustee acts as rental agent. Otherwise, there’s at least the appearance if not the reality of self-dealing when the trustee chooses to pay herself rather than someone else to do the same work at the same price.
I sometimes get questions about professional trustee fees as well, which usually fall into two categories. In one, the beneficiaries ask why they need to pay so much when all the trustee is doing is investing assets, which could easily be in index funds at almost no cost. The answer is that they often do a lot more than this, making discretionary distributions of principal, communicating with beneficiaries about their needs, completing trust accountings, and providing security for the trust assets. (You can read more about trustee duties here.)
The other complaint is about attorneys who charge by the hour for serving as trustee. It then becomes expensive to simply communicate with the trustee, especially if the communications don’t go well. I find that this comes up most often with smaller trusts which other professionals are unwilling to take on because the percentage fees would be too small to make it worth their while. There’s usually not much to be done about this except to make sure that the beneficiary has a trustee with whom he or she feels comfortable. It’s one thing to pay a trustee for services and communications which are supportive and another to do so for those that are fraught.
2. Does the trust have to file its own tax return?
If it’s a revocable trust, the answer is no. All bank accounts and investments should be in the grantor’s Social Security number and taxed directly to him or her.
If it’s an irrevocable trust, the answer is probably yes, though there are some exceptions. Some irrevocable trusts hold nonproductive real estate or other assets that don’t produce income. In that case, they don’t need to obtain a tax identification number or file an annual income tax return.
Irrevocable trusts that do earn income must file a return but still often pay no tax because any income that is distributed to beneficiaries is taxed to them. The trust files a 1041 income tax return reporting the income, but deducting the amount distributed. It then sends the beneficiaries K-1 forms reporting the income, which are like 1099s from banks or investment firms.
3. What rights to information do the beneficiaries have?
A beneficiary’s right to information depends in large part on whether the trust is revocable or irrevocable. Beneficiaries of revocable trusts generally have no rights at all because the grantor can always change the terms of the trust. In legal speak, their rights haven’t “vested” until the grantor passes away and the trust becomes irrevocable. (This can sometimes become confusing because the title of the trust might still contain the word “Revocable” but since only the grantor could make changes, it has become irrevocable.)
Beneficiaries of irrevocable trusts, on the other hand, generally do have considerable rights, including the right to a copy of the trust document, to regular (usually annual) accounts of trust financial activity, and in some cases to change trustees. These rights might be affected by the terms of the trust itself and state law. In addition, these rights generally only accrue to vested beneficiaries.
For instance, the trust may say “pay income to my daughter for life and then principal to her children who survive her in equal shares.” The daughter is a clear beneficiary with clear rights. The grandchildren’s interests are a bit less clear since they have to survive their mother to get anything, but they’d still probably have a right to see the trust and to annual accountings. The trust might also say that if a grandchild dies before the daughter, his or her share will go to his or her children — the greatgrandchildren. They would have no rights regarding the trust because their interest only occurs if their parent predeceases their grandmother.
4. Can the beneficiaries replace the trustee?
Probably yes. The trust instrument may give them that right, though often with restrictions. For instance, it might require that all the beneficiaries agree or that the new trustee be a professional, such as a bank, trust company or attorney.
Whatever the trust may say, state law may also give beneficiaries the right to remove and replace trustees, but in this case they would probably have to go to court to make this change. Fortunately, in most states, the law has become more lenient with adoption of the Uniform Trust Code. Under prior law, beneficiaries had to prove some malfeasance or incompetence on the part of the trustee. The presumption was in the trustee’s favor since the grantor chose the trustee in the first place, and the burden of proof was on the beneficiaries seeking a change. This could be a high bar to get over especially since the trustee could use the trust resources to hire an attorney in its defense and the beneficiaries would have to pay their own legal fees. (This might be reversed in the case of true trustee malfeasance, not just incompetence, but the beneficiaries could not be assured of successfully proving this and getting reimbursed for their fees.)
Fortunately, the Uniform Trust Code recognizes that communication between trustees and beneficiaries is very important to trusts fulfilling their purpose and that beneficiaries should not be burdened with a trustee in whom they have no confidence. So it permits the change of trustees for a breakdown of communication as long as all the beneficiaries are on the same page. They’ll still have to go to court, but the proceeding will be much less expensive and the outcome much more assured. It can still be difficult, however, if the beneficiaries are not in agreement.
5. Does the trust avoid probate and estate taxes?
Yes and no. If the trust is funded, meaning assets have been retitled in the name of the trust, those assets will not have to go through probate up on the death of the grantor. However, they still may be subject to an estate tax. This is a common misunderstanding. The “probate” estate only includes property that passes under the decedent’s will (or under the state’s rules of “intestacy” in the absence of a will). Property passing through joint ownership, by beneficiary designation or in trust avoids the expense and delay of the probate process. However, all such property is still in the taxable estate and potentially subject to estate taxation.
Fortunately, with the federal estate tax threshold currently set at $11.7 million (and twice this amount for married couples), very few estates pay any tax at the federal level. However, 17 states have their own estate or inheritance tax with thresholds as low as $1 million in Massachusetts and Oregon. So the trust assets could be subject to a state estate tax.
That said, for the most part only trusts created by the person who died are subject to tax on his or her estate. Trusts are often used to shelter funds so that they will be available to the surviving spouse but not taxed upon his or her death. (These are often referred to as “credit shelter,” “QTIP,” or “A/B” trusts.) Trusts created by a third party, such as a parent or a grandparent will not be taxed when the beneficiary passes away.
This is the fifth in a five-part series about trusts. The other articles are:
Harry S. Margolis is a Massachusetts estate and elder law planning attorney. He answers consumer questions about estate planning at AskHarry.info and most recently published The Baby Boomers Guide to Trusts: Your All-Purpose Estate Planning Tools.