When my children were young, I used to read Dr. Seuss books to them. One of their favorites was The Cat in the Hat Comes Back. You may remember the plot where the devious cat covers the interior of the house with pink spots while mother is away. When the kids are afraid that the mess can’t be cleaned up, the cat reveals one cat after another inside ever-decreasing sized hats, one on top of the other, kind of like a Russian Matryoshka doll. All of the little cats cause an even bigger mess, eventually cleaning it up before mother returns.
Wearing more than one hat can be a problem in an estate plan as well. An example of this is when someone is both a trustee for their deceased loved one’s trust and also a beneficiary of that same trust. Let me explain.
Suppose that Father’s trust is held for the benefit of Victoria, his second wife. Victoria is to receive income for the rest of her life, and, if the income is insufficient for her needs, the trustee can invade the principal of the trust for her health, maintenance, and support. Upon Victoria’s death, the trust terminates back to Father’s children, Sandy and Maria. Victoria is not Sandy and Maria’s mother, but Victoria is also the trustee of the trust.
Here Victoria is wearing “two hats.” As trustee of the trust, she has a responsibility not only to her own needs – to provide herself income and possibly invade the principal of the trust for her own benefit – but she is also supposed to be watching out for the needs of the remaindermen beneficiaries – Sandy and Maria. It would appear that Victoria has a conflict of interest, which is quite common in these scenarios.
A trustee would have to balance the investments for both income (which benefits Victoria) and growth (which benefit Sandy and Maria). As a beneficiary, Victoria would want to weigh the investment portfolio to maximize the income earned so that she has more money to spend every month. But when a trustee invests for income, it is usually at the expense of growth. Sandy and Maria want the trustee to invest for growth, since they want the trust to increase in value during Victoria’s lifetime, if not only to keep pace with inflation.
Keep in mind that every dollar that Victoria spends – especially principal dollars of the trust – is one less dollar that Sandy and Maria will one day receive as inheritance. Even if Victoria has a loving relationship with her step-children, legally she and they have adverse legal interests. What they will want from the trust is in direct conflict.
Victoria, therefore, is vulnerable. If she acts too much in her own favor, then Sandy and Maria could sue her for breach of her fiduciary duties. What if Victoria has a true medical emergency and invades the principal of the trust for many thousands of dollars? The trust seems to indicate that this is okay, but would your opinion change if Victoria had millions of her own outside of the trust?
This is where good drafting comes into play. The trust could read, for example, that when making principal distributions the trustee should consider the other income and resources available to the beneficiary. It may also read that the trustee is to favor the income beneficiary’s needs over those of the remaindermen, or vice versa. It’s not a bad idea for the grantor of the trust to direct his attorney to write an “intent” clause:
“It is my intent that the trustee first consider the needs of my wife should she survive me, over the needs of my children, even to the extent of the exhaustion of the trust funds. In making these decisions, however, my trustee shall consider the outside income and resources available to her,” for example.
Yet another good idea is to name an independent party as a co-trustee to weigh in on investment and distribution decisions. This may serve Victoria well, by taking some of the responsibility off of her shoulders.
There are many ways to “skin the cat” in this type of situation. A “standard” trust that does not delve into the grantor’s priorities and intent could actually cause more problems than it solves. My book, Selecting Your Trustee, is slated to come out later this year, and it will go into much more detail concerning this and topics similar to it. Be sure to continue reading this column for updates.
The Sheppard Law Firm has its main in Fort Myers and also in Naples by appointment.
© 2017 Craig R. Hersch. Originally published in the Sanibel Island Sun.