Trustees’ Distribution Risk: Getting to Know You
By: Russell J. Fishkind, Esq.
New Jersey State Bar Association Mid-Year Conference
November 9, 2018
Clients engaged in estate planning generally seek to pass their wealth tax-efficiently to those they love with the hope that the executed estate planning documents will affect their intentions. To the extent trusts are created, trustees assume fiduciary responsibilities not only to prudently manage the trust corpus but also to make distributions as directed by the governing trust instrument. Sometimes the clients and nominated trustees discuss how best to distribute the trust corpus to the beneficiary… sometimes not. Sometimes the nominated trustees really understand the needs and resources of the beneficiary… sometimes not. And sometimes trustees feel confidant when exercising their discretion to pay out income or principal, and sometimes…they see a docket number in their future.
Ambiguity is the birthplace of litigation. When a trust agreement directs the trustee to remit income and/or principal of the trust to, or on behalf of a beneficiary, in their sole and absolute discretion, the trustee assumes an enormous burden. What if the beneficiary is a gambler, a spendthrift, a drug addict, or one who struggles with special needs? What is the trustee’s duty to know about the beneficiary’s challenges and available resources? As the case law and the Uniform Trust Code develops, it’s becoming clear that if income and/or principal is to be remitted at the trustee’s sole and absolute discretion, then the trustee has a duty to know the beneficiary and, in many instances, what resources are available to the beneficiary. The more discretion granted and the more challenged a beneficiary may be, the more risk the trustee assumes with every distribution.
Conversely, a mandatory distribution standard requires the distribution of income or principal, or both, in a manner that generally does not require the exercise of a trustee’s discretion or the corresponding duty to know the beneficiary. The most common mandatory distribution clauses require the distribution of all income, monthly or quarterly. In such instances the trustee’s risk may be limited to asset management, the prudent investor rule, and making sure the trust’s total return is reasonable together with the timely remittance of income, tax reporting and accounting. In contrast, discretionary distribution standards require the consideration of numerous factors. Sometimes the considerations are patently obvious, but more often, a prudent discharge of duties may require a deep dive into the beneficiary’s life before making any distributions. Arguably, the most risk a trustee could assume is to be trustee of a supplemental needs trust, (SNT). As the following language makes clear, the SNT trustee is charged not only with having a comprehensive and thorough understanding of the effects of each and every distribution but with determining how the distribution will be utilized and if the distribution is in the beneficiary’s best interest.
A fairly standard SNT might include the following language:
Supplemental Needs Trust
Property that is to be held in the trust for the BENEFICIARY shall be held under this article and all references to a “Trust for the BENEFICIARY” shall be to the trust held under this article.
- During the BENEFICIARY’s Life.
The following provisions shall apply during the BENEFICIARY’s life:
- The trustee shall collect income and, after deducting all charges and expenses attributed thereto, shall apply for the benefit of the BENEFICIARY, in-kind, so much of the income and principal (even to the extent of the whole) as the trustee deems advisable in their sole and absolute discretion subject to the limitations set forth below. The trustee shall add all undistributed income to the principal of the Trust.
- Consistent with the trust’s purpose, before expending any amounts from the net income and/or principal of this trust, the trustee shall consider the availability of all benefits from government or private assistance programs for which the BENEFICIARY may be eligible. The trustee, where appropriate and to the extent possible, shall endeavor to maximize the collection and facilitate the distribution of these benefits for the benefit of the BENEFICIARY.
- None of the income or principal of this trust shall be applied in such a manner as to supplant, impair or diminish any governmental benefits or assistance for which the BENEFICIARY may be eligible or which the BENEFICIARY may be receiving unless, in the sole and absolute discretion of the trustee, such use of income and/or principal is beneficial to the BENEFICIARY.
- The BENEFICIARY does not have the power to: (a) revoke this trust or (b) assign, encumber, direct or authorize distributions from this trust for his or her support and maintenance.
- Notwithstanding the above provisions, the trustee may make distributions to meet the BENEFICIARY’s need for food, shelter, health care, or other personal needs, even if those distributions will impair or diminish the BENEFICIARY’s receipt or eligibility for government benefits or assistance. The trustee may make these distributions only if the trustee determines that the distributions will better meet the BENEFICIARY’s needs, and it is in the BENEFICIARY’s eligibility for or receipt of benefits. However, if the mere existence of this authority to make distributions will result in a reduction or loss of the BENEFICIARY’s entitlement program benefits, regardless of whether the trustee actually exercises this discretion, then this paragraph 5 shall be null and void and the trustee’s authority to make these distributions shall terminate. As a result, the trustee’s authority to make distributions shall be limited to purchasing supplemental goods and services in a manner that will not adversely affect the BENEFICIARY’s government benefits.
- With the trustee’s consent, any person may, at any time, from time to time, by Court order, assign, gift, or transfer, by deed or will, or provide income or add to the principal of the trust created herein. Any property so added shall be held, administered and distributed under the terms of this trust. The trustee shall execute documents necessary to accept additional contributions to the trust and shall designate the additions on an amended Schedule A of this trust.
- It is my intent that the trust assets be utilized to maximize the potential and enjoyment of the BENEFICIARY’s life. The trustee may utilize trust assets for the sole benefit of the BENEFICIARY by providing the following not otherwise provided through government entitlements: education, services, vacations, transportation, recreation, aids, services of accountants, attorneys, social workers, medical, personnel, treatments, equipment, companions and feeders. I give to the trustee discretion as to the use of these funds so as to enhance the BENEFICIARY’s life. I desire that the trustee exercises the discretionary powers conferred in this article in such a manner as will provide flexibility in the administration of the trust and, in exercising such powers, the decision of the trustee shall be conclusive as to the advisability of any distribution of income and/or principal, and as to the BENEFICIARY to or for whom such distribution is to be made and such decision shall not be subject to judicial review.
- The trustee, during the BENEFICIARY’s lifetime, may utilize trust funds to provide for a prepaid burial plan including an irrevocable funeral trust.
- Upon the BENEFICIARY’s Death.
- Upon the BENEFICIARY’s death, the property then held in his or her trust shall be distributed by the trustee to the BENEFICIARY’s descendants then living, per stirpes, provided, however that any distribution of a share of the remaining trust property to a descendant shall be distributed instead to the trustee of the descendants’ separate trusts. Such share shall be held as a separate trust and shall be disposed of under the terms of the descendants’ separate trusts under this trust agreement, the descendant for whom the share was set aside to be the beneficiary of his or her own descendant’s separate trust.
It stands to reason that before distributing income and/or principal, the trustee must fully appreciate both the beneficiary’s challenges and available resources, and then, acting as a reasonably prudent trustee, distribute such resources in a manner that enhances the beneficiary’s life while simultaneously protecting any government benefit programs or resources. As if that’s not already a meaningful obligation, trusteeship of a supplemental needs trust is never on autopilot; it’s an ever-changing landscape and distribution risk exists with every remittance.
Such risks were recently addressed when a New York Trial Court ordered the Trustee to reimburse a special needs trust for almost $180,000 that it over distributed on private caregivers, cab rides, and medications that could have been obtained from government sources. See Liranzo v. LI Jewish Education / Research (N.Y. Sup. Ct., Kings Cty., No. 28863/1996, June 25, 2013).
This case was based on a Trust created for the benefit of Eirol Liranzo who was injured as a child. As reported, in 2003, the remaining $422,012.54 from the settlement of his personal injury lawsuit was placed into a Special Needs Trust for his benefit. The Trustees were authorized to spend not less than $1,500 a month on Eirol’s living expenses, but the Trust also specifically stated that the Trustees must make a good-faith effort to determine whether Medicaid would cover home health care services prior to expending trust funds for that purpose. The Trust also required the Trustees to take Eirol’s eligibility for government benefits into consideration before making discretionary payments to him or his family.
By 2009, less than $4,000 remained in the Trust. When the Trustee, BNY Mellon, filed a petition requesting that the Court approve its account and release it as Trustee, the Court instead opened an investigation. The independent examiner discovered that BNY Mellon had paid for $118,064.50 worth of home health care costs without making an inquiry into whether Eirol could qualify for Medicaid coverage. BNY Mellon had also paid for $56,320 worth of cab fares for Eirol’s family and had made payments to the family that rendered Eirol ineligible for SSI and Medicaid.
The Supreme Court of New York, Kings County, ruled that BNY Mellon must repay the Trust for $176,905.99 that it improperly distributed while it was Trustee. The Court found “it is clear that the Trustee relegated [its duties] to others, failing to make the necessary inquiries to ensure the longevity of the Trust Fund. It is clear to the Court that BNY breached its duty under the Trust agreement and failed to properly administer the Trust.”
Since the Trustee had discretion to remit income and/or principal, subject to benefits otherwise available, the Trustee was charged with having a duty to understand the beneficiary’s unique needs, to inquire about his resources, and the benefits available to him before making any distributions on his behalf. Such an obligation is ongoing – from the first distribution, to the last distribution.
Only six months prior to that decision was the Matter of JP Morgan Chase Bank, N.A. (Marie H.), 2012 NY Slip Op 22387 decided on December 31, 2012. Another case involving a beneficiary who had special needs, another case where the Trustees had absolute discretion to remit income and/or principal on behalf of the beneficiary, and another decision in which the Trustees were held liable for breaching their fiduciary duty to know the their beneficiary. Despite language in the Trust Agreement, which was funded with over $2.7M, requiring distributions for Mark’s “care, comfort, support and maintenance,” JP Morgan failed to appreciate and provide for his needs.
In this case the beneficiary, Mark, suffered from autism, “was non-verbal, and engaging in numerous repetitive and self-stimulating behaviors,” he also was “engaged in frequent aggressive behaviors including spitting, throwing objects and hitting his own head.”
At the initial hearing the individual Co-Trustee testified that he had not physically seen Mark in years, had never visited Mark, nor had he inquired to see if Mark had any unmet needs. A trust officer from Chase testified that their “excuse” for inaction was out of lack of institutional capacity to ascertain or meet the needs of a severely disabled, institutionalized beneficiary. Trustees’ commissions were taken, but no distributions were made to enhance Mark’s life, no visits, no inquiries. The Court found that the Trustees had left Mark to languish for several years with inadequate care even though his Trust had ample resources. The Court ruled that the Trustees breached their duty to inquire and apply trust resources toward improving Mark’s life.
In both cases, the Trustees failed to know and appreciate the nuances of each beneficiaries’ needs and available resources. Consequently, as Trustees, they failed in discharging their duty to prudently exercise the required discretion.
The duty to know the beneficiary and understand the beneficiary’s needs is escalated when a Grantor creates a supplemental needs trust; Beneficiaries of such trusts may be entitled to government benefits such as Medicaid or Social Security/Disability and an improper distribution of either income or principal may lead to disqualification from such benefits. Moreover, some beneficiaries will not be able to effectively advocate for their needs, placing the onus on the fiduciary to be proactive. Accordingly, there is a higher duty for the trustee to know the beneficiary’s unique challenges, their income potential, mobility, nutritional needs, medical challenges and housing requirements – and with a greater duty comes greater fiduciary risk.
Implementing the intentions of the grantor or testator and guarding against distribution risks are not mutually exclusive goals, but there is no bright-line test to determine as a condition precedent to making a distribution, if the trustee is sufficiently aware of all relevant considerations for every individual SNT beneficiary. While not a bright-line test, New Jersey has recently adopted the Uniform Trust Code, 3B:31-57 entitled, Duty of Prudent Administration which requires that “a trustee shall administer the trust as a prudent person would, by considering the purposes, terms, distributional requirements, and other circumstances of the trust. In satisfying this standard, the trustee shall exercise reasonable care, skill, and caution”. Further, 3B:31-67 entitled Discretionary Powers provides, “Notwithstanding the breadth of discretion granted to a trustee in the terms of the trust, including the use of such terms as “absolute,” “sole,” or “uncontrolled,” the trustee shall exercise a discretionary power in good faith and in accordance with the terms and purposes of the trust and the interests of the beneficiaries”.
Thus, in an effort to prudently administer a special needs trust or discretionary trust, and to ensure that the trustee reasonably exercises its discretion in the interest of the beneficiary, a trustee should know and consider at least the following information about the beneficiary:
- The beneficiary’s ability to earn income and manage money.
- Residential housing situation.
- Medical history.
- Known mental or behavioral challenges.
- Eligibility for government-sponsored benefit programs.
- Ability to work.
- Ability to communicate.
- Capacity for independent living.
- Whether any other trusts have been created for the beneficiary.
- Legal issues.
- Has a guardian of the person or property been appointed?
- Does the trust include a conflict resolution process?
- Has a power of attorney been executed?
- Was there a personal injury claim (that led to the need for the trust?)?
- Has the trust been reported to Medicaid?
- Has a decision been made to forego public benefits?
- Is there an Achieving a Better Life Experience (ABLE) Act of 2014 account?
- Is there a distribution plan or life care plan for the beneficiary?
- Is there a budget for care that includes a Monte Carlo simulation risk analysis?
- Who will pay the income taxes incurred by the trust?
- Is the trust a first-party or third-party trust agreement?
- A list of the beneficiary’s family and friends including contact information.
- If protocols for visits, contact or communication should be created.
- Where is the trust sitused?
- Who the remainder persons are and what duty is owed.
- History of adversarial communications
- Frequency of distribution requests
These questions are not exhaustive and are not static. Every time a trustee considers making a distribution a review of such factors is required. Incorporating a life care plan prepared by skilled social worker, psychologist, or trained coordinator will further minimize risk.. A life care plan for a beneficiary with autism, will be very different than a life care plan for a beneficiary with intellectual challenges or a beneficiary with schizophrenia. Accordingly, the plan should incorporate all the above factors, together with an assessment of the beneficiary’s, strengths and weaknesses, hobbies, travel preferences and activities of daily living. Such data will provide the trustee with the insight and guidance needed to understand the beneficiary and how to meet their needs while within the trust’s budget. A tailored life care plan often proves to be an invaluable source of information for a trustee seeking to prudently fulfill not only its legal obligation, but also to enhance the beneficiary’s life – the goal when the estate planning effort commenced.