A remainder beneficiary is a beneficiary of a trust whose benefit vests at a later time. As an example, I may receive income for life and only upon my death what is left of the corpus of the trust goes to my son. I am the income beneficiary and my son is the remainder beneficiary.
In most family trust situations, we have the surviving spouse the income beneficiary, sometimes with the right to invade for need, and the remainder going to the children. This is often called a “QTIP” trust under the IRS rule that allows such a trust to qualify for the marital deduction.
But many trusts of all sorts have both income beneficiaries and remainder beneficiaries and it is important to note that such trusts may be revocable by the trustor or not. Indeed, often the trustor is the initial income beneficiary, then the surviving spouse the next income beneficiary, and finally, the children or grandchildren or other persons are the remainder beneficiaries.
The problems arise when the interests of the income beneficiary do not match the interests of the remainder beneficiaries. Assume you are the trustee of X Trust. The income beneficiary is the surviving spouse who wants you to make significant distributions to him or her and invest trust assets in his or her business. The remainder beneficiaries want less income to go the surviving spouse and do not want a risky investment to be made in the business of the income beneficiary. They would like to see you invest trust assets in bonds or stocks on public exchanges or even certificates of deposit which generate little income but are quite safe so that when they finally get their share, as much of it is remaining as possible.
You are the trustee and both the income beneficiary, and the remainder beneficiaries are owed fiduciary duty by you.
What do you do? Whose interest predominates?
What we are really dealing with here is a potential conflict of interest. The trustee must treat all beneficiaries equally and with no favoritism and cannot personally be in a conflict of interest with beneficiaries. But here the beneficiaries, themselves, have a conflict of interest. What the remainder beneficiaries may see as an appropriate investment or risk or an appropriate level of income distribution may not satisfy the income beneficiary.
The Trust Instrument:
The first place to find an answer is in the trust instrument itself. If well drafted the trust, itself, will answer all questions as to potential conflicts of interest between income and remainder beneficiaries. The trustor (or settlor, another term used for the person creating the trust) can make sure that the trust instrument addresses this very question. A typical clause will state the following: “The Trustee is instructed that the welfare of the income beneficiary is of greatest concern to the Trustor and is to take precedence over the interests of any remainder beneficiaries.” That simple sentence is binding on the Trustee and eliminates the need for the Trustee to worry about the inherent conflict.
Sadly, many trusts are not written with such provisions and that lack can cause the problems itemized below. It is essential for anyone considering creating a trust to ensure that appropriate wording is inserted so that the Trustee is not caught attempting to reconcile competing fiduciary duties. Any experienced attorney should be able to provide the correct language. If not, the following approaches may be considered.
Agreement of the Beneficiaries:
Assuming that the beneficiaries are of legal age and fully advised, their written consent to a proposed action is useful but does not fully eliminate the duty on the part of the Trustee to make the appropriate decision. The Trustee may be required to protect their interests regardless of their instruction since it is the Trustor, not the beneficiaries, who set the terms of the trust up which binds the trustee.
But many beneficiaries do not want to put their own interests over other family members so a fully written agreement with full written disclosure of the pros and cons of a decision and with independent legal counsel available to advise the beneficiaries would do much to protect the trustee from later claims of conflict of interest. A trustee that wants additional protection can seek an order of the court affirming his or her decision.
It the above solutions are not available, one turns to statutes and case law.
State law applies in this area and the states do not always agree. In a trilogy of recent cases, courts in three states have addressed the issue of whether the trustee of a revocable trust has a duty to account to, and can be held liable to, the remainder beneficiaries of the trust for a period during which the trust was revocable.
Keep in mind that once the trust is irrevocable, the trustee has the full power to make all decisions, subject to his or her duty to the beneficiaries. But assuming the trustee is serving in a trust that can be revoked at any time by the trustor, does the trustee still have to protect the remainder beneficiaries when the income beneficiary-trustor is still capable of revoking the entire trust and reclaiming all the assets at any time?
The three cases are: (i) the Iowa Supreme Court case of In the Matter of Trust # T-1 of Mary Faye Trimble, 86 N.W. 2d 474 (Jan. 2013); the California Supreme Court case of In re Estate of Giraldin, 290 P.3d 199 (Dec. 2012); and the Arizona Court of Appeals case of Pennell v. Alverson, 2012 WL 4088679 (Ariz. App. Div 1, Sept. 18, 2012).
Based on these three cases, as well as the previously decided Missouri case of In re Stephen M. Gunther Revocable Living Trust, 350 S.W. 3d 44 (Mo. Ct. App. 2011), it is clear that, while a trust is revocable, the trustee has a duty only to the settlor, and that even after the death of the settlor when the interests of the remainder beneficiaries has vested, the trustee continues to have no duty to the remainder beneficiaries for any actions taken while the trust was revocable. In other words, based on these cases, it appears that during the life of the settlor, the trustee has a fiduciary duty only to the settlor, even after the death of the settlor, so that the remainder beneficiaries cannot bring claims against the trustee for any breach of fiduciary duty to themselves.
On the other hand, the remainder beneficiaries may have standing to bring claims against the trustee for a breach of fiduciary duty to the settlor that occurred during the settlor’s life, other than any such breach consented to (actually or implicitly) or directed by the settlor, if such breach adversely affects the interests of the remainder beneficiaries
The California Case Expanded:
The decision in the Giraldin case places new responsibilities and extended potential liability on any trustee acting even while the Settlor is living, including a spouse-Trustee administering a joint trust. It is worth examining in detail:
Facts of the Case. In Estate of Giraldin, December 20, 2012, the Settlor (Father) named Son as sole trustee of the Father’s revocable trust (Trust). Son acted as trustee while Father was living. Father invested his funds in a business that Son partly owned, the start-up company SafeTzone Technologies Corporation (SafeTzone).
Father then contributed his stock in SafeTzone to the Trust. Son retained the Trust investment in SafeTzone even though it became almost worthless. Father never objected to the SafeTzone investment, and the Trust instrument provided wording that gave broad protection to Son acting as Trustee.
At Father’s death Son’s siblings, remainder beneficiaries of the trust, filed suit against Son, seeking an accounting and recovery of those investment losses claiming the Son failed to act as a prudent trustee, risked their eventual inheritance, even though the Father was still alive and could, presumably, have revoked the Trust and regained control of the assets at any time.
The legal issue was whether the other children could sue Son for actions he had taken during Father’s lifetime. The Son argued that the Father could take back the assets at any time so if anyone could complain, it would have been the Father and by leaving the assets in the Trust, the Father had made his choice. The remainder beneficiaries contended that they had standing to pursue the trustee for Father’s economic loss after Father’s death since they were the ones destined to inherit.
Holding: The Supreme Court agreed with the remainder beneficiaries. A trustee of a revocable trust may be required to account to the remainder beneficiaries after the settlor’s death for actions that the trustee took during the settlor’s life. The trustee may be liable if the trustee did not follow the settlor’s directions or otherwise breached a duty to the settlor. Remainder beneficiaries unaware of a Settlor’s finances during the Settlors’ life, and not necessarily knowing Settlors’ desires may seek to recover a “missing” inheritance from a trustee.
Effect of Direction by the Settlor. The Settlor may dissipate trust funds as the Settlor chooses. The Trustee has no duty to prevent the Settlor from a knowing, voluntary use of revocable trust assets. In the Giraldin case the siblings as remainder beneficiaries could not pursue Son for losses caused by Father’s informed decisions.
But a Trustee may find it difficult to prove that the Settlor made a particular decision. It is critical in such a situation to make full, written disclosure and consent from the Settlor to avoid later possible disputes.
Spouse as Trustee. The effect of Estate of Giraldin may be most pronounced when a married couple serves as cotrustees of their joint trust, or one spouse acts as sole trustee upon incapacity of the other. Children from a prior marriage or disgruntled children may use the decision in Estate of Giraldin to require a surviving spouse to account for years of trust administration when financial records may not be readily available. They may seek to recover a loss in value of the trust property from the surviving spouse, if he or she cannot produce evidence to show that the deceased spouse approved a trustee action.
Again, clear records and informed written instruction and consent of the Settlor is vital to avoid later claims years down the road. An ounce of such prevention is worth a ton of cure…for the cure in court is sure to be expensive!
Irrevocable Trust and the Conflict of Interest of Remaindermen and Income Beneficiary:
The Giraldin case, by implication, makes it clear that once irrevocable, all the beneficiaries are owed a fiduciary duty which cannot be surmounted by the ability of the trustor to revoke. And here we have a balancing of interests which the Trustee is required to perform. The Prudent Investor Rule, applicable in most states, imposes a reasonable person test on the investments that a Trustee may make and using that tool the Trustee must decide if investments sought by the income beneficiary meet that requirement.
This is particularly true where the investments are inherently high-risk investments, such as investing in a business operated by the income beneficiary. Absent wording in the Trust that so allows or agreement in an acceptable form by all beneficiaries, such a high-risk investment would be very dangerous for the Trustee since the remainder beneficiaries could later claim breach of duty to them.
But obtaining a reasonable income from trust assets has also been required under the Prudent Investment Rules and failure to do so is, itself, a breach of duty. The courts have held that keeping the money in cash or cash equivalents earning less than the level of inflation can be considered a breach of fiduciary duty in itself.
Thus, the Trustee must balance both the risk of investment with the need for appropriate income flow and is well advised to retain the services of financial advisors. If advised by experts and avoiding undue risk, the Trustee is probably safe from later claims of breach of duty.
The income beneficiary and the remainder beneficiaries are usually in an inherent conflict of interest, whether they know it or not, and it is up to the Trustee to recognize that and seek ways to minimize the danger of breach of duty. At times the remainder beneficiaries, not willing to upset a spouse or parent, do not voice their concerns (and growing anger) until after the income beneficiary is deceased and then claim the Trustee breached his or her duty by giving way to the income beneficiary.
Thus, the Trustee must be proactive in ensuring that all interests are protected, whether the income beneficiary or remainder beneficiary complains or not. By using one of the methods outlined above, or actually petitioning the court for instructions, the Trustee can assure doing what is right and avoiding risks of later claims of breach of duty.