Trust management help

[Nastavnik]

Hi all! Long time lurker.

My best friend and cousin has a mother in law who began an irrevocable trust in Illinois and he’s in charge of investing the money placed in it. He’s never done anything like this and asked me where I’d start and I said this website but he asked me to post for him.

Kinda overwhelmed by all the info so hopefully someone can narrow it down for him with some good advice or links.

The money won’t be needed to live off of and his mother in law just wants him to grow it as much as possible for her grandkids. Can we get some recommendations on the kind of accounts to invest the money in? Personally I use a vanguard account and invest in index funds, but maybe that’s not best for him for tax reasons?

Thanks in advance for all your help for a beginner!

[Skiandswim]

You might need to ask you friend for specific details on the Trust to get better advice. Each trust has unique aspects to consider.

For instance, is you friend is a Trustee for the Irrevocable Trust? If she is not a trustee, then what is the formal relationship to beneficiary?

It is common for Irrevocable Trusts to require all or some of the net income to be distributed. What are the trust requirements? Someone assisting with investments needs to understand distribution terms (and tax implications).

What are the trust investment objectives ? There are definitely some personal risks providing such advice.

There are several reasonable cost options for trust investment management that might be considered, before your friend engages in assisting:
Vanguard (0.55% with $3500 minimum): https://personal.vanguard.com/pdf/s341.pdf?2210071322
Fidelity (0.45% with $4500 minimum): https://www.fidelity.com/bin-public/060 ... _trust.pdf
Schwab: (0.50% unclear on minimum): https://www.schwab.com/public/schwab/in ... t_services

[Nastavnik]

Thanks for the reply! I got some details from him

He is the sole trustee and has full power to invest as much or all of the assets into whatever investment he sees fit. His mother in law is the main beneficiary who wants a small amount (1%) per year and his wife will take little to no revenue. The goal is just to grow this money as efficiently as possible. The tax options as he understands them would be best to distribute all income so the trust nets zero, and his wife and her mother would pay income tax on those distributions and then the net could be reinvested into the trust. The trust is irrevocable so when her mom passes there won’t be inheritance tax.

He’s looking at lots of vanguard funds. Are there funds specifically designed for this purpose? I’ve told him any dividends he gets will have income tax on them, but stocks owned that don’t pay dividends but grow in value over the years will only have capital gains tax when I sold. Is this thinking correct? For this reason should they look at individual stocks over mutual funds or are there mutual funds that accomplish this task?

Sorry lots of information there. Appreciate your responses.

[gokartmozart]

The first place to start is to read the trust instrument (document) very carefully. I am assuming your cousin is named as the trustee in the trust instrument.

You write that "the money won't be needed to live off of" but it is quite common for trust instruments to specify that trust income must be paid out to some specified person as it is earned. If this is the case with your cousin's trust, then the trustee (presumably your cousin) is legally bound to pay out the income. If this is not what the parties want then there's a disconnect that should be addressed. Either the income beneficiary needs to explicitly agree (preferably in writing) to forego the income, or the trust instrument needs revision.

Your cousin can establish a trust account with Vanguard or most any brokerage. This works very much like a personal account and is just about as easy to open. One difference is that the brokerage will often ask for a copy of the trust instrument. I suppose they want to see the trustee's name on the instrument to be confident they are dealing with the authorized trustee. Where a normal individual account might be in the name of "John Doe", a trust account will be named something like "John Doe, Trustee. Doe Family Trust".

As a starting point for how to invest the funds, your cousin might think about how many years the money will be invested. Some trust instruments say the grandkids get the money right after grandma dies; others say the grandkids get it when they turn 35 (or 50!). This could be 5 years or 30 years depending. If the answer is 30 years, then the asset allocation could be 90/10. If it is 5 years then maybe 10/90.

For someone new to investing (your cousin?), I'd recommend the three-fund portfolio with the asset allocation above. It is also chosen by experienced investors who want to keep things simple yet effective.

When I was new to being a trustee I found "The Trustee's Legal Companion" (Nolo Press) very helpful.

[RickBoglehead]

Whatever he distributed they should not be giving back to the trust.

A 3 fund portfolio as normally stated is tax efficient.

A trustee that doesn't do their own research is troubling to me "She told me" is not a viable response to improper investments. Depending on the value, Vanguard PAS at 0.3% may make sense, at least initially.

Based on your post, and his understanding that you posted, he needs to carefully read the trust document. An irrevocable trust doesn't allow beneficiaries to provide input to my knowledge.

[gokartmozart]

Sorry I was composing my previous reply when you posted more information so my previous reply was a little off target in places.

Taxation of trusts is much, much steeper than that of individuals. Compare the tax tables in the instructions for Form 1041 with the same in Form 1040. Look up the tax that will be due on the expected income of the trust versus the same amount added to the income of the beneficiary and then decide if you want it taxed at the trust level or the beneficiary level.

I'm not aware of any mutual funds that are specifically designed to be held by trusts.

Boglehead investing philosophy says don't own individual stocks, own diversified mutual funds instead. Diversification greatly reduces risks.

From your comment about trying to choose stocks which don't pay dividends, you might want to look into tax managed funds.

[gokartmozart]

Whatever he distributed they should not be giving back to the trust.

RickBoglehead, could you clarify what you meant by "should not"? Is it a matter of not legal or not advisable or not reasonable and why.

As far as I know it would be legal for a trust to distribute income to a beneficiary, then the beneficiary would pay taxes on the distribution, then the beneficiary could gift the net after taxes to the trust. (Provided gift tax rules were respected, etc.) But I would like to hear otherwise if I am wrong.

[RickBoglehead]

Whatever he distributed they should not be giving back to the trust.

RickBoglehead, could you clarify what you meant by "should not"? Is it a matter of not legal or not advisable or not reasonable and why.

As far as I know it would be legal for a trust to distribute income to a beneficiary, then the beneficiary would pay taxes on the distribution, then the beneficiary could gift the net after taxes to the trust. (Provided gift tax rules were respected, etc.) But I would like to hear otherwise if I am wrong.

Legal, sure. Smart?

Goal would be to minimize distributions IF trust specifies that. Again, beneficiary as no say, trust document does.

[megabad]

The first place to start is to read the trust instrument (document) very carefully.

+1. Ultimately, it doesn't matter what the beneficiary or the trustee or you or bogleheads think, trustee will need to follow the directives laid out in the trust documents. Without more info, I would simply recommend implementing a strategy that uses low expense investments (like low ER index funds).

[RetiredArtist]

When I was a trustee, the trust lawyer told me to seek professional advice re suitable investments for the trust.
I used a one time, fee-only advisor, acting as a fiduciary (for the interests of the beneficiaries/remaindermen).
Edited to add- in our case, Vanguard Personal Advisor Service said they could not help, as they did not know the situation/needs of the beneficiaries.

[Nastavnik]

He has a link to this thread and is getting back to me with more details. Appreciate the thoughts and advice given so far very much everyone!

[smackboy1]

My best friend and cousin has a mother in law who began an irrevocable trust in Illinois and he’s in charge of investing the money placed in it. He’s never done anything like this and asked me where I’d start and I said this website but he asked me to post for him.

A forum is not really the best place to get the counsel the trustee requires. Trusts can be complicated and without reading and understanding the entire document, it's impossible to give accurate advice. For example, this trust sounds like it could be a non-grantor trust, but is that accurate? Does it have grantor trust options? Was this drafted by a lawyer and what were their instructions?

A trustee is a fiduciary which means they have a legal duty to act in the best interests of the beneficiaries. They really cannot just do whatever they want, especially if they lack experience and knowledge. They would be liable to the beneficiaries. Having all the beneficiaries "part of the family" is not a shield. In the future the spouse or child of a beneficiary acting on their behalf could bring a lawsuit against the trustee for breach of duty. In this situation trustee should paper the trail with reasons for decisions - from professionals.

Generally, trusts have an accelerated tax schedule compared to individuals. So in 2018 trust retained net income over $12,75 pays the top rate (compare to over $500,000 for individuals).

One strategy is to distribute net income to beneficiaries (if they are in a lower tax bracket). This is a tax decision that trustee will have to make every year. There is a 65 day window after Dec 31 when the trustee can do the tax calculations and decide whether to make a distribution, which would be attributed to the just ended tax year.

A second strategy is for the trust to invest in tax efficient investments. For example Vanguard has a few tax efficient funds. Use tax exempt bonds as part of the fixed income allocation. Minimize tax inefficient investments e.g. REITs, dividend heavy funds.

Third: don't let the tax tail wag the dog. Look at the big picture. Sometimes it's OK to pay a little more tax for better ROI, lower risk, creditor protection, etc..

Gifting money distributed to beneficiaries back to the trust could potentially create problems. I would not consider doing this without talking to a lawyer about the possible consequences.

[bsteiner]

...
My best friend and cousin has a mother in law who began an irrevocable trust in Illinois and he’s in charge of investing the money placed in it. He’s never done anything like this and asked me where I’d start and I said this website but he asked me to post for him.
...
The money won’t be needed to live off of and his mother in law just wants him to grow it as much as possible for her grandkids. ...

...
He is the sole trustee and has full power to invest as much or all of the assets into whatever investment he sees fit. His mother in law is the main beneficiary who wants a small amount (1%) per year and his wife will take little to no revenue. The goal is just to grow this money as efficiently as possible. ...

It would be unusual for someone to create a trust and be a discretionary beneficiary during her lifetime. It would help to know the trust provisions regarding distributions. To whom, when and for what purposes may or must or may not make distributions?

...
It is common for Irrevocable Trusts to require all or some of the net income to be distributed. ...

It's generally preferable for distributions to be discretionary, but it would be helpful to know what this trust permits, required or prohibits with regard to distributions.

As to income taxes, most trusts created during lifetime are grantor trusts (in other words, the grantor is taxable on the trust's income and gains during her lifetime). But it would be helpful to know whether this trust is a grantor trust (and whether grantor trust status is intended, and if it's a grantor trust but it shouldn't be, or if it isn't a grantor trust but it should be, whether it's possible to change the status).

If the trust isn't a grantor trust, the income taxes at the trust level aren't as bad as they're often made out to be. Trusts mainly receive qualified dividends, tax-exempt income, and long-term capital gains. They reach the 23.8% rate on qualified dividends and long-term capital gains at a low level, but it's sometimes worth accumulating the income and paying 23.8% on these items, though that's something the trustees can decide each year. Also, if the trust isn't a grantor trust, it's often possible to set it up so it won't pay state income tax in any state. If the income would otherwise be subject to state income tax, that may offset the difference in the Federal tax rate.

As to how to invest the trust assets, it would help to know the current and expected future needs of the beneficiaries. The trustees would invest differently if there's a current beneficiary who needs the income (or perhaps more than the income) from the trust or if no one is likely to need any distributions for many years.

[Nastavnik]

Hey guys! Continued thanks from both myself and my cousin.

I DO want to make a few things clear. The trust was created by a law firm that specializes in trusts alone, was made specifically to cater to the beneficiaries desires, and the trustee (my cousin and buddy) is currently interviewing multiple financial advisers. He’s a smart guy and absolutely has his ducks in a row. He has a masters degree from the University of Illinois and a very successful business and is successful financially. But he’s also never managed a trust and is gathering information to do the best job he can going forward. Thus, our conversations and me mentioning this website and him asking me to get some opinions from lots of different sources so he can explore all options to determine the best way to go forward with the management of the assets.

As I stated in the original message the goal of the trust is an avoidance of estate taxes while growing the principal for her grandkids. Her request is an income from the trust of 1% per year to marginally increase her style of living, but the goals as stated by the trust is for the rest of the money to grow as tax advantageously as possible so there’s a nice chunk there for grandkids when she passes on. His job as trustee and as specifically stated in the trust is to accomplish these goals to the best of his ability. Also specifically stated in the trust is the trustee has broad discretion in the management of the funds as well as the distributions.

I’ll do my best to answer your guys questions that he and I already discussed.

He is the sole trustee and his mother in law is the primary beneficiary and his own wife is also a beneficiary.

He’s not required to do ANY distributions if he thinks they are unneeded. The trust explicitly says that all income need NOT be distributed. The main goal of the trust is NOT income generating for the beneficiary. The goal of the trust is mostly legal avoidance of estate taxes and growth of principal for descendants.

One mistake I made in an earlier reply and it was not his mistake, but mine, was that he can make distributions to the beneficiaries, have them pay income tax on what the trust has earned, and then reinvest the net back into the trust. Whoever said that they thought this was not possible in an asset protecting irrevocable trust was correct. His goal is to have “some” income for the trust (whether that’s rent from real estate, dividends from stocks, etc) that is somewhere from 1-2% of the total assets, and for the rest of the trust to grow with long term capital gains.

The trust can probably expect to be in existence 10-25 years.

We didn’t discuss the question but from my understanding it’s a non grantors trust.

Smackboy, appreciate your input and he had specifically brought up the strategy of using tax exempt municipal bonds to pay his mother in law her requested 1% distribution each year and then invest the rest of the money into tax efficient funds.

[gokartmozart]

Your cousin-buddy sounds like he's going to make a fine trustee: financially sophisticated, diligent, doing his homework. Good news for everyone!

One more tip I have for your cousin-buddy is to get ahead of, and stay ahead of, the need to provide trust accountings. Trust accountings are not the same as standard business accountings. They have their own format and terminology. Often state law dictates they must be provided to beneficiaries at least yearly. Some states permit the trust instrument to modify the schedule to a limited extent, or for the beneficiaries to waive accountings (get any waiver in writing!)

The trust accountings will have to balance to the penny. The trustee is required to substantiate accounting items with records if asked. Keep records of every penny that goes into or out of the trust. Keep PDF scans of all trust-related receipts, check images, and every financial statement. Keep them organized by date and category.

One can hire accounting firms which specialize in trust accountings. (The same firms often specialize in trust tax prep.) Some trustees DIY the accountings. However there is a learning curve even if one already is familiar with standard business accounting, and any error could give a beneficiary grounds for a lawsuit if the beneficiary was so inclined.

[Nastavnik]

Can anyone speak to tax free municipal bonds? It’s not something he or I have any investments in, but he thinks they could be a nice asset to the trust.

https://www.forbes.com/sites/michaelfos ... 7f1f8717eb

This seems a little too good to be true?

[gokartmozart]

Can anyone speak to tax free municipal bonds?
...
This seems a little too good to be true?

I'm sorry I can't answer that directly but perhaps I can point you and your cousin in a helpful direction. It's a rule of thumb that higher-yielding investments carry higher risks. Is that the case here? And if so are you comfortable carrying whatever extra risk to get the extra return? So do some research into the risks of muni bonds vs otherwise comparable govt or corporate bonds.

You mentioned a desire to keep income in the trust. Given trusts' accelerated tax brackets I can understand your interest in tax-free income.

The wiki has a page on munis: https://www.bogleheads.org/wiki/Municipal_bonds

[bsteiner]

... His mother in law is the main beneficiary who wants a small amount (1%) per year and his wife will take little to no revenue. The goal is just to grow this money as efficiently as possible. .... The trust is irrevocable so when her mom passes there won’t be inheritance tax.
...

If she created the trust and she's a beneficiary, why won't it be subject to estate tax in her estate? Is the trustee in an asset protection jurisdiction such as Alaska, Delaware, Nevada or South Dakota?

... the goal of the trust is an avoidance of estate taxes while growing the principal for her grandkids.
...
The trust can probably expect to be in existence 10-25 years.

We didn’t discuss the question but from my understanding it’s a non grantors trust.
...

If the purpose is to grow the money for the grandchildren, why will the trust run out in 10 to 25 years?

If the mother-in-law created the trust and she's a beneficiary, how is the trust not a grantor trust? (It's possible to create a trust for your own benefit and have it not be a grantor trust, and we sometimes do this to avoid state income taxes, but it's complicated.)

The asset allocation may depend on the purposes of the trust, and other factors. If the trustee wants to hire someone to manage the trust assets, Vanguard will do it for 0.3% a year (less if it's over $5 million), plus the cost of the underlying mutual funds.

[Nastavnik]

Appreciate it gokartmozart!

Bsteiner, I’m sure I’ve got some of the details incorrect in the recanting of my buddy’s situation. He assures me that all is well, the trust was written by a law firm specializing in trusts, and then read over by two other lawyers from different law firms to make sure everything was done exactly like the family was hoping. I know a few extra details but don’t want to share anything overly private about the family’s details.

My main goal, and what he asked me to do, was explain the situation as much as needed to get some advice on best strategies for investing the assets.

I also think he should give vanguard’s trust department a call.