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Discretionary Dilemma: Trustee Consideration of Beneficiary Financial Resources

By Jacob L. Geiermann

Trust instruments often provide trustees with discretion to distribute trust assets to or for the benefit of the beneficiaries. By their nature, discretionary trusts often create difficulties in ongoing administration. One common, but often overlooked, difficulty in administering discretionary trusts is determining whether and how the trustee should consider beneficiary financial resources when making discretionary distributions.

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Background

This article highlights a subtle area of trust law that could have significant implications to trust beneficiaries and trustees alike but that has received only limited consideration over the years by practicing attorneys and academics. Professor Edward C. Halbach, Jr. first published his authoritative article, Problems of Discretion in Discretionary Trusts, in 1961 in the Columbia Law Review. 61 Colum. L. Rev. 1425 (1961). Professor Richard C. Ausness recently published an article entitled Discretionary Trusts: An Update in the ACTEC Law Journal to provide an update to Professor Halbach’s article. 43 ACTEC L.J. 231 (2018).

In his article, Professor Ausness notes that “although there have been a number of significant developments in [the area of discretionary trusts since 1961], very little scholarship has been produced [since then].” Professor Halbach’s article provides some of the most thorough scholarly coverage of the issue of beneficiary financial resources this author has discovered and is worth a close reading by estate planning attorneys and trust officers seeking to better understand this nuanced issue.

Professor Ausness provides an excellent update on key issues concerning the administration of discretionary trusts. Unfortunately, for sake of brevity, Professor Ausness intentionally omitted a more substantial discussion on the issue of consideration of beneficiary resources. Gerry Beyer and Alexander Bove, Jr. have suggested that a more thorough coverage of the issue of trustee consideration of beneficiary resources would be helpful, along with practical guidance for attorneys seeking to address this important issue in trust drafting. See Gerry W. Beyer, Reactions to Discretionary Trusts: An Update by Richard C. Ausness, 43 ACTEC L.J. 435-440 (2018); and Alexander A. Bove, Jr., Commentary on Discretionary Trusts: An Update by Richard C. Ausness, 43 ACTEC L.J. 441-445 (2018). This article attempts to provide a practical summary of the issue of trustee consideration of beneficiary financial resources and is intended to assist practicing attorneys who are drafting and administering discretionary trusts.

Overview

When creating a trust, the settlor has broad authority to dictate the terms governing the trustee’s exercise of a discretionary power to distribute trust assets. Inclusion of a trust provision expressly prohibiting or requiring trustee consideration of beneficiary financial resources falls squarely within the scope of such authority. See UTC § 105.

In general, a trust settlor can include the following three types of provisions in a trust instrument: (1) a provision prohibiting trustee consideration of beneficiary resources, (2) a provision requiring trustee consideration of beneficiary resources, and (3) a provision giving the trustee discretion to determine whether and to what extent beneficiary resources will be considered.

Another common possibility is that a trust instrument does not include an express provision regarding trustee consideration of beneficiary resources. If silent on this issue, the trustee is in a difficult position when considering requests for distributions. Although default rules may exist under the general common law of trusts, which will be further discussed below, the parameters of the default rules are not clearly defined.

Uniform Trust Code. Several provisions of the UTC and its Official Comments provide guidance on the administration of discretionary trusts. Most relevant to the issue of beneficiary resources, the Official Comment to UTC § 814 states that “[a] grant of discretion establishes a range within which the trustee may act. The greater the grant of discretion, the broader the range.” The Comment further notes that under § 50 of the Restatement (Third) of Trusts (Third Restatement) “whether the trustee has a duty in a given situation to make a distribution depends on the exact language used, whether the standard grants discretion and its breadth, whether this discretion is coupled with a standard, whether the beneficiary has other available resources, and, more broadly, the overriding purposes of the trust.”

In addition, despite trust provisions giving the trustee broad discretion, the UTC requires that the trustee always administer a trust in good faith and in accordance with the trust terms, the trust purposes, and the interests of the trust beneficiaries. See UTC §105(b)(2), § 801, and § 814(a).

Finally, in administering trusts with two or more beneficiaries, the UTC requires that the trustee “act impartially in investing, managing, and distributing the trust property, giving due regard to the beneficiaries’ respective interests.” UTC § 803. The Official Comment to UTC § 803 notes that “[t]he duty to act impartially does not mean that the trustee must treat the beneficiaries equally. Rather, the trustee must treat the beneficiaries equitably in light of the purposes and terms of the trust.” Although this provision of the UTC is relevant with respect to the interests of current versus remainder beneficiaries of a trust, it is similarly relevant when administering a “pot trust” for the benefit of two or more current beneficiaries, which can create difficulties in administration when a trust with limited funds can be used for beneficiaries with differing needs and circumstances. The difficulty in administering a pot trust can be further exacerbated if beneficiary resources are being considered by the trustee.

Though the UTC allows a settlor to include express trust provisions concerning trustee consideration of beneficiary resources, it does not create a statutory default rule if the trust instrument is silent. Because the default rules under the general common law of trusts are not well defined—as discussed below—perhaps this issue could be better addressed by the inclusion of a statutory provision within the UTC. Determining how such a statutory default rule might operate, however, is outside the scope of this article.

Section 106 of the UTC states that “[t]he common law of trusts and principles of equity” supplement the UTC to the extent they are not inconsistent with the UTC or other state law. As stated in the Prefatory Note to the UTC, the UTC was “drafted in close coordination with the writing of the Restatement Third [of Trusts].” State statutes and case law should first be consulted before relying upon the general common law of trusts as expressed in the Third Restatement. In jurisdictions that have adopted the UTC but that do not have any governing statutory authority or case law, however, consideration of the Third Restatement would likely be a reasonable fallback.

Restatement (Third) of Trusts. The default rules under the Third Restatement regarding trustee consideration of beneficiary resources are substantially different from the prior default rules under the Restatement (Second) of Trusts (Second Restatement). Comment e to section 128 of the Second Restatement had stated that “[i]t is a question of interpretation whether the beneficiary is entitled to support out of the trust fund even though he has other resources. The inference is that he is so entitled.” Section 50 of the Third Restatement now states that “a trustee, in determining the distributions to be made to a beneficiary under an objective standard (such as a support standard) . . . is to consider the other resources but has some discretion in the matter.”

Although the Second Restatement would generally make beneficiary resources irrelevant when considering discretionary distributions, the Third Restatement generally requires consideration of beneficiary resources but gives the trustee “some discretion” to disregard beneficiary resources. The Third Restatement only provides limited guidance as to when and how the trustee should exercise its discretion to disregard beneficiary resources.

General Comment e to section 50 of the Third Restatement provides the guidance summarized below concerning a trustee’s consideration of beneficiary resources, but notes that “the cases, frequently even within a jurisdiction, are in conflict [with respect to consideration of beneficiary resources].”

  • First, a trustee must act reasonably in ascertaining the needs of trust beneficiaries but can generally rely on a beneficiary’s representations and require disclosure of only minimally intrusive information from the beneficiary. Id. at General Comment 50(e)(1).
  • Second, the trustee should consider the beneficiary’s assets, income, pensions, annuities, and court-ordered support payments and should also take into account the income tax, estate tax, and other tax purposes which the trust serves. Id. at General Comment 50(e)(2).
  • Third, a trustee should take into consideration a married person’s right to support from his or her spouse and a dependent child’s right to support from his or her parents. Id. at General Comment 50(e)(3).
  • Fourth, a trustee should consider a beneficiary’s eligibility to receive public benefits, should exercise its discretion in a manner that will not disqualify the beneficiary from such benefits, and should not expend trust funds if public funds would otherwise be available to meet particular needs of the beneficiary. Id. at General Comment 50(e)(4).
  • Fifth, if a trust instrument does not provide specific guidance regarding trustee consideration of beneficiary resources and rules of construction do not adequately address the matter in a particular instance, the trustee should consider the trust’s overall purposes in determining whether and how to take into consideration beneficiary resources. Id. at General Comment 50(e)(5).

In addition to the above guidance, the Third Restatement further suggests that, even when a beneficiary’s resources generally are not to be considered by a trustee, the trustee should nonetheless take into account the trust’s income distributions to the beneficiary. Id. at comment e.

The Third Restatement also suggests that a trustee may be able to make inferences about the trustor’s intentions about whether and to what extent beneficiary resources should be considered by a careful review of the trust provisions as well as the circumstances in existence at the time of the drafting of the trust instrument, including, but not limited to, the following:

  • The extent of discretion granted to the trustee, such as limited discretion (health, education, maintenance, and support) versus unlimited discretion (sole and absolute discretion);
  • Inclusion of trustor statements of intent, such as precatory guidance and other provisions memorializing the trustor’s intentions when creating the trust;
  • Inclusion of restrictive terms, such as “but only if” or “only to the extent that” or “only in the case of an emergency”;
  • Inclusion of expansive terms, such as “including, but not limited to” or references to a beneficiary’s “happiness” or expenditures for “luxury” items;
  • Inclusion of provisions stating a preference for one or more individual beneficiaries or class of beneficiaries;
  • Inclusion of provisions authorizing exhaustion of trust principal for the benefit of one or more individual beneficiaries or class of beneficiaries;
  • The beneficiaries’ accustomed standards of living at the time the trust instrument was drafted; and
  • The relationships among the trustor and the beneficiaries at the time the trust instrument was drafted.

Trust Drafting

Although the above default rules arguably apply under the general common law of trusts, drafting attorneys should recommend to their clients the inclusion of express guidance in the trust instrument regarding trustee consideration of beneficiary financial resources.

Prohibiting Consideration of Beneficiary Resources. One option is to simply prohibit the trustee from considering beneficiary resources. The following is a common trust provision prohibiting consideration of beneficiary resources:

The Trustee may distribute to the Primary Beneficiary as much of the income and principal of the trust as the Trustee deems advisable for the Primary Beneficiary’s health, education, maintenance, and support, without taking into account the Primary Beneficiary’s other financial resources.

The simplicity of this type of provision may be appealing, but this provision often may not be a good standard in practice because it effectively makes beneficiary resources irrelevant—i.e., for distribution purposes, it would not matter whether a beneficiary is a multi-millionaire or destitute. Most trust settlors generally view a beneficiary’s financial resources as a relevant consideration when a trustee is considering requests for discretionary distributions.

Requiring Consideration of Beneficiary Resources. Another option is to expressly require the trustee to consider beneficiary resources. The following is a common trust provision requiring consideration of beneficiary resources:

The Trustee may distribute to the Primary Beneficiary as much of the income and principal of the Trust as the Trustee deems advisable for the Primary Beneficiary’s health, education, maintenance, and support, but only after the Trustee determines that the Primary Beneficiary’s other readily available financial resources are insufficient to reasonably provide for the Primary Beneficiary’s health, education, maintenance, or support.

One difficulty with the above provision is the extent to which the trustee must obtain and examine documentation evidencing beneficiary resources or the lack thereof. Another issue is determining the degree to which beneficiary resources or the lack thereof should weigh in favor or against the trustee’s exercise of discretion to distribute trust assets. If a beneficiary has significant financial resources, the existence of such resources would seem to tend against discretionary distributions. If, however, the beneficiary’s financial resources are invested in illiquid assets, the question arises whether the beneficiary must first attempt to divest such investments or if a discretionary distribution would instead be justified. If a beneficiary lacks his or her own financial resources and has only modest income-earning potential, these factors would seem to favor of making discretionary distributions. If, however, the beneficiary is subject to creditors’ claims or other types of liabilities, the trustee might wish to withhold distributions because of the existence of such liabilities.

To improve upon the above provision, perhaps consider including any one or more of the following provisions to provide additional guidance to the trustee:

  • A provision identifying the types of assets, liabilities, and cash flow items that the trustee should take into account;
  • A provision stating whether and how a beneficiary’s interest in other irrevocable trusts should be taken into account;
  • A provision stating whether a beneficiary’s legal right to support from his or her spouse should be taken into account;
  • A provision stating whether a beneficiary’s legal obligation to support his or her spouse and children should be taken into account;
  • A provision stating whether a beneficiary’s legal right to public benefits should be taken into account;
  • A provision stating whether a beneficiary’s employability and income earning potential should be taken into account, especially when a beneficiary is unemployed or underemployed; and
  • A provision providing general guidance as to whether a beneficiary’s financial resources (or lack thereof) should weigh in favor or against discretionary distributions. This type of provision should specifically address whether a beneficiary must have little or no independent financial resources before discretionary distributions would be permitted, or if, instead, a beneficiary could receive discretionary distributions despite having some level of financial resources.

Discretionary Consideration of Beneficiary Resources. Another common trust provision states that the trustee “may, but is not required” to consider beneficiary resources when making discretionary distributions. Although this provision might modestly bolster the discretionary nature of a trust, without more it fails to provide any practical guidance to the trustee when considering requests for distributions. If the trust instrument does not provide more specific instructions, the trustee will likely need to resort to the same analysis that would apply in the absence of any guidance at all.

To improve upon this approach, consider including any one or more of the following provisions to provide additional guidance to the trustee:

  • A provision providing guidance on the types of circumstances in which the trustee should ordinarily consider beneficiary resources;
  • A provision providing guidance on the types of circumstances in which the trustee ordinarily should not consider beneficiary resources; and
  • To the extent that the trustee is to consider beneficiary resources, inclusion of provisions providing guidance of the types set forth in the immediately preceding section of this article.

Trust Administration

If a trust is already irrevocable, the trustee will generally need to administer the trust under its existing terms. The express terms of the trust instrument are of primary concern to the trustee, but the trustee must also be mindful of how statutory and common law rules apply in the absence of specific guidance.

Communication of Guidelines to Trust Beneficiaries. Although the interpretation and construction of the terms of a trust instrument are critical, equally important is the trustee’s communication with the beneficiaries concerning the trustee’s position as to whether and how beneficiary resources are to be considered when making discretionary distributions.

The Third Restatement suggests that “the trustee’s duty to keep beneficiaries reasonably informed, together with the trustee’s duty of impartiality, entitles the beneficiaries to disclosure of the bases upon which the trustee’s discretionary decisions have been or will be made.” Third Restatement at General Comment 50(e)(1). In most instances, the language in the trust instrument itself will be insufficient to articulate all guidelines regarding trustee consideration of beneficiary resources. Therefore, the trustee should communicate its position in the form of written guidelines sent to the beneficiaries. The written guidelines should be based upon the trust terms, statutory law, case law, and the general common law of trusts.

Although differences of opinion may exist concerning the exact parameters of such guidelines, the adoption and communication of written guidelines to the trust beneficiaries would be prudent. Adoption and communication of written guidelines would document the trustee’s reasonable attempt to administer the trust in an impartial and even-handed manner and would evidence the trustee’s good faith effort at communicating the terms of the trust administration to the beneficiaries. Providing written guidelines to the beneficiaries also gives the beneficiaries an opportunity to object or consent to the guidelines, which could then give rise to a nonjudicial settlement agreement or court petition, if necessary.

If Trust Instrument Silent. The common law default rules under the Third Restatement are set forth above. A trustee administering a trust that is silent on the issue of consideration of beneficiary resources should thoroughly document the trustee’s position on whether and to what extent beneficiary resources will be considered when the trustee is considering requests for discretionary distributions. The trustee should then adopt written guidelines and provide a copy of such written guidelines to the trust beneficiaries.

Mandatory or Discretionary Consideration of Beneficiary Resources. In administering a trust that requires the trustee to consider beneficiary resources or gives the trustee discretion to consider beneficiary resources, the trustee should first rely upon any express guidance and inferences from the trust instrument. If further guidance is needed, the trustee should resort to the same type of analysis that would apply in the absence of a trust provision, keeping in mind that the trustor has either expressly directed the trustee to consider beneficiary resources or expressly given the trustee discretion to decide whether and to what extent to consider beneficiary resources.

Conclusion

Whether and how a trustee considers beneficiary financial resources can have significant implications for the beneficiaries. Estate planning attorneys should give this issue sufficient consideration when discussing the creation of irrevocable trusts with their clients. Trustees who are administering discretionary trusts should thoughtfully consider and communicate this issue with the trust beneficiaries, mindful of the fact that different guidelines will likely be appropriate for different trusts.

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By Jacob L. Geiermann

Jacob L. Geiermann is a trusts and estates attorney at JD Legal Planning in Fargo, North Dakota, and is a Fellow of the RPTE Section.