Protect Your Inheritance: Why Trusts Are Flawed

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A common estate planning device, a trust is a legal structure that dictates how and when assets should be passed to beneficiaries. A well-designed trust can be a useful tool for preserving wealth for future generations. However, even a seemingly solid trust carries the potential to be mismanaged and provoke a costly, painful and lengthy legal battle among beneficiaries.

Below, we’ve explored the three most common problems you should be aware of when planning your estate.

Adverse trustees

Because a trustee is responsible for overseeing and managing its assets, a trust may be only as effective as the agent you appoint as trustee.

However, finding a trustee who is objective, reliable, and competent can be surprisingly tricky. While your instinct may be to assign a relative or friend, such an individual may be too close to your family to treat all beneficiaries impartially. Professional trustees — such as lawyers or accountants — may also prove problematic if they choose to handle assets in a way that benefits themselves rather than your beneficiaries.

Particularly when dealing with substantial assets, many families turn to a bank or trust company — called corporate trustees — to manage their trust. While corporate trustees may be able to bring structure and impartiality to the process of trust administration, they can also create a different set of conflicts. Corporate trustees can be costly and difficult to remove. And because banks and trust companies are businesses, they may be more rigid when making distribution decisions due to increased liability and responsibility to shareholders.

Mismanagement of assets

Whether mishandled deliberately or inadvertently, mismanaged trusts can result in unwanted and costly consequences to beneficiaries. Common behaviors that may constitute trust mismanagement include:

  • Failure to provide accurate accounts. A trustee has a responsibility to keep accurate records of investment, distributions, and other actions involving trust assets. Failure to do so may so constitute a breach of their duties. In addition, if a trustee cannot provide timely and accurate records to beneficiaries, or if they attempt to conceal investments or other actions involving assets, this may be a sign of additional forms of impropriety in their trust management.
  • Failure to properly distribute assets. In some cases, even well-meaning trustees can fail to properly distribute assets. Particularly if the trustee is not a professional, they may simply be overwhelmed by the responsibility of paying creditors, handling taxes, and distributing assets from different accounts. In other instances, a trustee may unlawfully divert assets in the trust for their own benefit.
  • Failure to protect assets. A trustee has a duty to safeguard the trust assets from depletion and theft. A trustee may be negligent in managing the trust by making reckless investments, sharing sensitive account information with third parties, wasting money, or otherwise failing to protect the best interests of beneficiaries.
  • Favoring one beneficiary to the detriment. A trustee has a strict duty to remain impartial when handling assets if the trust has multiple beneficiaries. When investing and managing assets, a trustee must take into account the different interests of all beneficiaries without being influenced by partiality or favor to some at the determinant of the others. It may constitute a breach of fiduciary duty if a trustee makes decisions that clearly benefit one or a few beneficiaries over the rest.
  • Using assets for personal gain. Often charged with overseeing large amounts of property and cash, trustees are prohibited from using trust assets for their own personal gain. Trust mismanagement may occur if a trustee personally or professionally benefits from the actions taken as a trustee.

Defending against adverse trustees and mismanagement

Unfortunately, filing a claim against a trustee who has mismanaged a trust can get complicated. When a trustee is a family member or friend, pursuing litigation for trust mismanagement can be especially emotional and result in division among family members.

In addition, as with all litigation, trust litigation has a statute of limitations attached to it. For beneficiaries, this allows only a limited window of time to file legal action against a trustee. While trust litigation involving a breach of fiduciary duties may be able to be extended, this is only possible as long as the fiduciary relationship exists.

Though they can be a useful tool for protecting your assets from creditors and estate taxes, trusts are by no means perfect. If you do decide to establish a trust to safeguard your wealth, it is critical to assign the right agent to act as trustee. Whether appointing a friend, family member, professional, or company as your trustee, reliability, professionalism, and objectivity are essential to reducing the likelihood of mismanagement.

When drafting a trust, it is equally important to use language that allows beneficiaries to easily remove or substitute an adverse trustee in the event of trust mismanagement. By doing so, you can help keep your beneficiaries from having to take on the complex and expensive challenge of filing litigation against an adverse trustee or in the event of mismanagement.

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