TIME TO TRUST YOUR TRUST FUND TO A PRO?
When bad investments eat up funds that were supposed to be preserved in a trust, beneficiaries often sue the trustee--a friend, a lawyer, or a bank that's charged with making responsible decisions about the money. One current case involves the heirs of former New York Governor Averell Harriman. They are accusing trustees Clark Clifford and Paul Warnke of squandering the family's fortune on a failed resort hotel rather than sticking to investment-grade securities.
Your family may never have the Harrimans' trouble. However, choosing the right trustee is more important than ever because new laws are expanding the freedom of trust funds to invest in growth stocks, mutual funds, and securities which were once off-limits. In the past, the trust laws of many states made preservation of capital a top priority, compelling trustees to stick with conservative investments--which sometimes didn't keep up with inflation or reflect beneficiaries' needs. This made it easier to appoint Uncle Harry as the trustee, since he could just sock everything away in Treasury notes and forget about it.
NEW THEORIES. Now, states are changing their laws to bring them into line with modern portfolio theory, which favors assembling a diverse asset mix
designed to achieve an overall objective. California, Delaware, Florida, Georgia, Illinois, Minnesota, Tennessee, Virginia, and Washington have all acted. New York's statute takes effect on Jan. 1, and about a dozen other states have similar amendments pending. Some of them use as a guide a model statute, the Uniform Prudent Investor Act, completed this past summer by a committee of trust experts.
The new rules encourage lawyers to provide greater flexibility in trust agreements. Now, the investment approach is allowed to take into account general economic conditions, inflation, tax consequences, needs for liquidity, and other considerations. For example, if the goal is to keep pace with inflation, the trustee might design a portfolio that includes growth stocks and riskier holdings. "Even derivatives can find a place in a trust if they're appropriate," says John Langbein, a law professor at Yale University.
As long as the overall strategy is consistent with the goal, laws should protect the trustee if any part of the portfolio goes sour. Given the added complexity of managing the money, however, it's important to pick a friend or relative with financial skill or to appoint a trustee who will delegate investment authority to professionals.
The new laws make it easier to do that. New York's statute, for example, permits trustees for the first time to hire investment professionals. But the selection must be made carefully, and the trustee remains liable for advisers' actions. In Florida and Illinois, by contrast, the trustee is not liable if advisers act irresponsibly.
In general, bank trust departments make better trustees than relatives or friends. For one thing, a bank has institutional safeguards against self-dealing and other breaches of fiduciary responsibility. At one time, banks had a reputation for investing trust funds too conservatively. But large regional banks can now put trust assets in proprietary mutual funds, some of which have been excellent performers. Before engaging a bank, however, you should request three years' worth of data on the returns for commingled trust funds under its management as well as trust assets placed in other investments. Also look into trust services that are offered by brokerage firms and money managers. Merrill Lynch, for example, chartered its first trust company in 1987 and now has trust departments in many parts of the country.
Choosing a corporate trustee should be based as much on chemistry as on dollars and cents. Most institutions charge 1% to 1.5% of a trust's value each year--and less for trusts exceeding $1 million. The relationship will matter more than the costs. For example, Bank One, Arizona provides a service for smaller trusts that range from $100,000 to $500,000. "A lot of institutions won't take accounts under a half-million," says Robert Johnson, executive vice-president at Bank One. Other banks emphasize their willingness to work with co-trustees to make the right investment choices. "It's wonderful to have the bank serve with trusted friends," says Jayne Lipe, executive vice-president at Overtin Bank & Trust in Fort Worth. For extra protection, make sure that the trust allows for a change in banks if the chosen one doesn't perform or meet general investment parameters.
Nonprofessionals still serve an important function in running a trust. But rather than encouraging a friend or relative to go it alone, set up a team. That increases the chances that all members will be qualified for the role they play.NEW CRITERIA TO CONSIDER
IN INVESTING TRUST ASSETS
-- General economic conditions
-- Possible effect of inflation or deflation
-- Expected tax consequences
-- The role that each investment plays within the overall portfolio
-- The expected total return from income and capital appreciation
-- Other resources of the beneficiaries
-- The need for liquidity, regular income, and preservation and appreciation of capital
DATA: UNIFORM PRUDENT INVESTOR ACT