Trusts are established with a variety of criteria and are individualized to the specific needs of the grantor. Some trusts may terminate shortly after the death of the grantor, while others may not.
In all situations, trust assets must be managed by the trustee or successor trustee in the best interest of the beneficiaries or the remaining beneficiaries, who are entitled to the assets when the trust expires.
A trustee is a person or entity that has been given control or powers of administration of assets in a trust, with a legal obligation to administer it only for specified purposes. A beneficiary may receive income from a trust, a final distribution, or both.
When a remaining beneficiary is designated, he or she is entitled to receive the trust principal once the beneficiary is required to provide income. At that point, the trustee transfers the remaining amount in the trust to the beneficiary.
ideas for trust investing
One of the basic rules of trust administration is that the trustee must act as a prudent investor. The Prudential Investor Rule means that when the trustee is given control over someone else’s assets, they must make investment decisions that can be expected of a person with reasonable intelligence, prudence, and discretion. This means choosing an investment that does not increase the risk of loss. The trustee should only invest clients’ funds in ways that can reasonably be expected to perform well.
Factors to consider:
— Portfolio Diversification: Is the allocation suitable for the purposes of the Trust? A portfolio that will be depleted within a short period of time should not be invested in high-risk allocations. Or vice versa: A trust with several years of its life should not be invested entirely in cash or in a very low-yield investment strategy. The allocation should be determined on the basis of the time period for which the trust will be in place.
— Account Title: Was the account opened under the correct title? Sometimes accounts are opened with incorrect title, confirm that the title is correct to eliminate future problems.
— Conflicts of Interest: Are You the Trustee and Beneficiary?
— Portfolio Rebalancing: Is the portfolio being rebalanced regularly? The portfolio needs to be rebalanced at least annually. Otherwise, the allocation will change due to market performance over time and may not meet your original intentions.
– Investment performance: How are the investments within the portfolio performing? Don’t just assume that an investment will perform as expected. At least annually, research investments to determine whether they are outperforming or underperforming their peers. When you’re in a sale position, realize there can be income tax implications and understand how a capital gain or loss will affect future tax returns.
– Investment restrictions: Are there investment restrictions that need to be addressed in portfolio allocation, eg, ethical, environmental, social and governance screens?
– Diversification: Do the beneficiaries or their families have other significant assets that must be acknowledged before allocating the investment portfolio? If you are managing trust funds that are heavy in a specific asset class, such as real estate, do not intentionally include more real estate in the investment portfolio.
– Frequency of distribution: Is cash distribution available to the fund? If you need to pay income regularly, consider opening an additional investment account to capture dividends and interest over the course of a month, quarter, etc. At the end of the period, transfer the income to the beneficiary.
— Portfolio Risk: Does the risk align with the timeline for future distributions?
— Investment Objective: What is the purpose of the portfolio, asset protection, income or growth?
A trust can hold a variety of assets, including stocks, mutual funds, exchange-traded funds, real estate investment trusts, businesses, municipal bonds, real estate, cash and other assets. Successful investing often requires careful and objective weighing of several factors by the trustee.
Do beneficiaries depend on trust income to supplement their income? Do the assets in the portfolio need to grow to be distributed later? It is important to understand whether a trust is growth-oriented, income-producing, or both growth-oriented and income-producing. The balancing act can be between increasing the assets of the trust for the remaining beneficiaries while providing a source of income to the current beneficiaries.
The trustee or investment manager must allocate the portfolio to address the directions of the trust that they are managing specific to the needs of the beneficiaries. If the trust is paying dividends monthly, quarterly or annually, a process must be put in place so that distributions are paid on time to the beneficiaries.
Minimizing taxes is another important duty for the trustee. A trust must file a tax return and report any qualified dividends, income, rental income, or capital gains from its investments to the Internal Revenue Service and the Franchise Tax Board. When a trustee makes a trust fund distribution of income to beneficiaries, the beneficiaries will be required to report the income on their individual tax return. The trustee must complete the trust tax return and provide K-1 Tax Form 1065 to the beneficiaries in a timely manner. This is specific to K-1 trusts and differentiates between how much is a trust distribution from the trust principal and how much is from trust income.
Given the duty to factor in taxes, it is important to understand the difference between short- and long-term gains and losses. Since long-term capital gains tax rates are lower than short-term tax rates, which are taxed at ordinary income rates, trust assets must be managed with this in mind. When possible, trustees should take care to avoid short-term gains.
Portfolio management should also include tax-loss harvesting. Tax-loss harvesting is the process of selling positions at a loss, offsetting them against embedded gains within the portfolio so that there is no net taxable gain when filing tax returns for the year. When the market is down, as we are experiencing now, investments should be reviewed to determine whether this strategy should be implemented.
Serving as a trustee is a position that should not be taken lightly. You were often placed in a trusted position by a dear family member or friend. You have a supreme duty of loyalty to the beneficiaries to operate the trust solely in their best interest. If this task becomes too cumbersome, remember that there are professional assistants who are experts in this area who can help.
Terry Parker is the Vice President of CAPTRUST Financial Advisors. He has practiced in the field of Financial Planning and Investment Management since 2000. Reach [email protected] via email.