Many revocable trusts continue on past the lifetime of the grantor to benefit a surviving spouse and children. A trust that continues on for a spouse may be known as a “marital,” “credit-shelter,” or “family trust,” and may be held solely for the spouse for her lifetime and then distribute to the children at her death. Sometimes a trust benefits both the spouse and the children at the same time. These are known as “sprinkle” trusts since the trustee can sprinkle the trust income and principal amongst a group or class of beneficiaries at the same time.
After your death you obviously can no longer act as the trustee of your own trust. So at this time, your successor trustee steps in. It’s at this point that the type of trust and how the trustee must invest and distribute the assets becomes a more difficult issue than it was during the grantor’s life.
Assume, for example, that upon your death your surviving spouse is to serve as the successor trustee of your trust, and that your trust continues on for her benefit. Assume this “credit shelter trust” pays her all of the income (interest and dividends) during her lifetime and that principal can be invaded if the income is insufficient for her “health, education, maintenance and support.”
What does that mean?
The words, “health, education, maintenance and support” may look familiar to you. If you are married, they likely appear in your own estate planning documents, leading you to wonder why they are prevalent. The reason is because these words appear in the tax code (specifically, Internal Revenue Code §2041) and are known as an “ascertainable standard.” This has estate tax implications excluding trust assets from a trust beneficiary’s estate for federal estate tax purposes, even if she is acting as a trustee.
Jim dies, and his revocable living trust is held for his wife Jane’s benefit for the rest of her life. Jane is to receive the income from the trust and principal may be invaded for her “health, education, maintenance and support.” Even though Jane is the trustee and can presumably remove significant sums from Jim’s trust over the course of her lifetime, his trust is not included in her estate for federal estate tax purposes because her withdrawal right is limited by the ascertainable standard.
This begs a question, however. Is a trust that mandates the distribution of income and a principal invasion power for “health, education, maintenance and support” enough direction so that all of the beneficiaries understand what rights and responsibilities they have?
Assume in my example above that Jane wants a new car. She decides on a Mercedes that costs $50,000. May she withdraw money from the trust to buy the car? Does that purchase constitute maintenance or support?
Would your answer change if the trust had $5 million in it? What about if the trust only had $300,000? What if Jane had more money in her own personal account than what the trust had in its account? Does your answer change if the beneficiaries who inherit the trust following Jane’s death are step-children as opposed to biological children?
These questions pose interesting dilemmas. Furthermore, distribution decisions aren’t the only subjective choices confronting the trustee. Consider the trust investments, for example.
Jane is the trustee of her deceased husband Jim’s trust that is to be held for her benefit, distributing annual income to her. As trustee, Jane decides to maximize the income of the trust so she invests in bonds and high dividend paying stocks. Jim’s two sons, Jason and John, who inherit the trust after Jane’s death, complain that Jane’s decision to maximize income damages the potential growth of the assets, and therefore the real value of the trust will decrease relative to inflation.
Absent direction in the trust instrument to the contrary, Jane as trustee has a fiduciary duty to balance her income needs against the needs of the remaindermen who inherit the trust following her death. Again, if you are a judge hearing a complaint filed by Jason and John, do you remove Jane as trustee if she chooses to maximize income? Does your answer change if Jane has sufficient assets of her own on which to comfortably live for the rest of her life? Does your answer change if Jason and John are multi-millionaires and Jane really does need to maximize income?
In order to avoid these sticky issues, trusts can be drafted to provide more objective standards than the loose “health, education, maintenance and support.” The trust could direct the trustee, for example, to consider the income and other resources available to the surviving spouse when making investment and distribution decisions. Instead, the trust could state that Jane is the primary beneficiary and her needs should be considered above the needs of the remaindermen, notwithstanding other assets or income available to her.
Most beneficiaries don’t file complaints against the trustee for these matters. It is costly, divisive and risky to do so. Nevertheless, when considering how and whether you want your trustee to favor one class of beneficiaries over another, it is always a good idea to convey those thoughts to your estate-planning attorney and to have him draft appropriate language satisfying your intent. Otherwise, the default provisions under the law apply which may or may not be consistent with what you want.