Over the past half-century, the role of trustees has evolved rapidly. These changes have spurred the evolution of the trust industry and presented new challenges to continued growth and profitability.
More Complex Structures
Trust-friendly laws allowing for directed trustees and perpetual trusts aren’t new concepts, but their proliferation in recent years and broad acceptance in many states have expanded the scope of trustees who must administer these complex structures. Starting in the mid-1980s, states began to compete for trust business using favorable trust laws as a lure to bring trust assets into their states. Many states began to repeal their common law rules against perpetuities to allow for perpetual trusts and to codify laws allowing the role of the trustee to be unbundled so advisors could direct how the trustee exercised its fiduciary powers, the so-called directed trust. Beginning with Alaska and Delaware in 1997, certain states began to apply spendthrift protections to self-settled trusts allowing for the creation of domestic asset protection trusts. Until this time, wealthy individuals had to use offshore asset protection trusts if they wanted creditor protection while retaining access to their assets.
During this period of evolution in the trust laws, differences in state income tax laws created opportunities for residents of one state to explore the use of personal trusts administered in another trust-friendly state for the purpose of minimizing their overall state income tax burden. The situs of trust administration became a compelling reason to seek a trustee located in a favorable jurisdiction like Delaware, South Dakota or Alaska. State income-tax arbitrage leads to complex trust structures used to minimize taxes on the recognition or receipt of income, the so-called incomplete gift non-grantor trust or ING trust, so the taxpayer remains a resident of their high-tax home state while exporting his assets to a trust in a low- or no-tax jurisdiction to limit state income taxes.
One challenge in the trust industry today is distinguishing between complicated trust structures that require a robust trustee who’s fairly compensated for these services versus trusts that may be serviced by a thinly staffed trustee for the purpose of essentially renting administrative situs in a preferred jurisdiction. Describing and demonstrating the value proposition regarding the services being performed may be a challenge for a corporate trustee because many families face the decision of whom to select as their trustee only once and don’t appreciate the downside to picking the lowest-cost provider. Advisors who regularly counsel families on these decisions, and who live with the poor results obtained from a less-sophisticated trustee, understand this value and can help families find the right fit. Trustee services aren’t a commodity because each trust relationship is unique.
Multi-National Families
A generation ago, interstate planning was a complicated factor when structuring a family trust. Today, it’s common to do trust planning for multi-national families impacted by the laws and taxes of multiple countries. The variety of domestic and foreign tax laws involved when planning for the multi-national family requires sophisticated tax counsel and a fiduciary partner able to meet the ongoing and evolving demands of these complex trust structures. Some multi-national families seek efficient methods for importing their wealth to the United States after their children come to the United States for an education and remain following marriage or to pursue professional opportunities. Others seek a safe haven for family wealth because their home country may be financially or politically unstable, with the United States seen as the “offshore” jurisdiction of choice. Finally, U.S. estate tax laws encourage the use of trusts to hold U.S.-based real estate by non-resident aliens to avoid U.S. estate taxes on their death.
Driving Forces
As trust and tax laws changed and investments became more complex, successful families sought the services of professional fiduciaries located in favorable jurisdictions who were adept at navigating these complex trust laws and able to take advantage of these modern investment options. The demand for fiduciary services made trust departments an attractive source of revenue to financial institutions, and some states began to compete to attract trust assets into their states. Some innovations in trust laws that states used to bring assets into their state (such as perpetual trusts, directed trustees and self-settled spendthrift trusts) made the role of a trustee so complex that only a professional fiduciary adept at navigating these complex trust laws is able to carry out the basic duties of the fiduciary. However, as the sophistication in the role of the trustee evolved to this point, pricing demands created by fierce competition for this fiduciary business put a strain on operating margins.
While some people improperly view the role of the directed trustee as an easy and passive job, the workload (and sometimes the risk) of the directed trustee is often greater than when a trustee holds all of the duties and responsibilities of a traditional trustee. Each new directed transaction carries with it a unique set of directives. The trustee must ensure that the directed transaction is proper—that is, the investment is permitted by the trust agreement, it’s legal and the trust qualifies to make the investment. For example, some unique circumstances can arise when a federally regulated financial institution is directed to invest in a marijuana production business that may be legal under state, but not federal law. The directed trustee must also understand whether it’s an accredited investor when directed to purchase securities that aren’t registered with financial authorities. While the role of the directed trustee may appear passive on paper and in concept, a trustee with a deep bench of fiduciary professionals is required to properly administer most directed trusts.
Sophisticated Trustees
The evolution of the trust industry has highlighted the fact that modern trusts require the services of robust professional trustees adept at navigating complex legal, tax, investment and regulatory issues. Sophisticated wealth planners demand the use of sophisticated trustees in preferred jurisdictions who have in-house legal, tax and administrative talent to deliver these complex fiduciary services. One challenge resulting from the proliferation of investment-directed trusts and thinly staffed trust companies willing to serve as trustee in name only is to put pricing pressure on these services when they are viewed as a commodity in the market. However, trustees with the depth of talent required to administer trusts for multi-national families, trusts holding unique investments, or trusts created in support of complex planning goals, may still be paid adequately for their services if they’re able to detail and demonstrate the value of their robust fiduciary services. In the end, the trust industry continues to thrive and meet the needs of wealthy multi-national families in this brave new world.