A Brief History of Trusts

In the years of the Crusades, the Crusaders often left their property to be used and protected by somebody while they were off fighting in the Crusades. This situation was often referred to as the “use.” Later, the word “trust” came into being because, after all, the question arose as to whom you would trust to maintain and protect your property during your absence. Trust, therefore, developed as a noun and later became a legal form.

An early trust provided that no property could ever be sold, no income would ever be distributed, and that the trust could last forever. Someone figured out that the trusts could, in the course of several hundred years, theoretically own a good portion of the planet. Therefore, three compelling rules came into effect that are still in effect in many states today.

3 Compelling Rules of Trusts

One is the rule against perpetuities, which means that a trust can last no longer than 21 years and 9 months after the death of a particular person living at the time the trust was created. The trust must then terminate and be distributed to the current beneficiary at that time. Of the three rules mentioned, the rule against perpetuities is increasingly being abolished or changed to accommodate perpetual and long-term dynasty trusts.
Second, is the rule against accumulation of income. This rule says you have to distribute income at some point during the life of the trust to prevent untoward accumulation. With the increasing disappearance of the rule against perpetuities, this rule may be becoming more relevant in some states.

Third, is the rule against direct restraints on alienation, which said that you cannot take property out of commerce by provisions in the deed or trust agreement. This would be against the public interest and would eliminate progressive development of properties, both real and personal.

The Two Classes of Property in a Trust

Property in a trust is divided into two classes: legal ownership and equitable/beneficial ownership. A trustee is the legal owner of the property; the beneficiary is the recipient of the benefits of the property. The trustee has afiduciary duty to honorably discharge the responsibilities and provisions of the trust without conflicts of interest and self-dealing. A fiduciary is held to a higher standard than what an individual would beheld to in the treatment and dealing with his own property, for a fiduciary must act in the best interest of someone other than himself.

As the trust evolved over the years (basically, in England),and as it came to the United States, the trustee was only authorized to sell property if it bought government bonds, as a protective measure against loss. Later it was determined that certain types of investments, such as common stocks, could be included but only on a “legal list” of companies in whose stocks the trustee could invest. This soon became a political football in that companies were lobbying state legislatures for approval to get on the legal list of investments.

After much consternation and litigation, the “prudent manrule” evolved which went something like this: “a trustee may buy, lease, mortgage, encumber and exchange any item of property–real, personal or mixed–which a prudent person would use for their own use, for investment, not speculation.”

This meant that the trustee can really invest in almost any type of property, so long as it can be shown that it is prudent, protected and in the best interests of the beneficiary. Over time, however, the prudent man rule, which had become a hallmark of conservative investing, became displaced by the modern portfolio theory which looked at the trustee’s portfolio as a whole.

The “prudent investor rule” was then adopted, which directs trustees to “invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements, and other circumstances of the trust.

In satisfying this standard, the trustee shall exercise reasonable care, skill, and caution.” This rule may be expanded, restricted, eliminated or altered by the testator or grantor in creating the trust.

Essential Relationships in All Trusts

A trust, as you will recall, involves the trustor or grantor, the creator of the trust; the trustee, the one to whom the trust is entrusted for execution of its terms and conditions, and the beneficiary, the recipient of the benefits of the trust.

The trust almost always, by its very nature, produces both an income beneficiary and a remainder beneficiary. In other words, the trustee is to provide the income from the trust for “X” and the “Y” gets the remainder.

This places the trustee in the unenviable position of difficult investment decisions because income, of course, is important to the income beneficiary and, later, the type of income–taxable versus non-taxable–whereas, the remainderman is more interested in capital appreciation or growth over the life of the trust which will, of course, inure to his or her benefit.

Indeed, unless the trust provides otherwise, “if a trust has two or more beneficiaries, the trustee shall act impartially in investing and managing trust assets, taking into account any differing interests of the beneficiaries.”

The Broad Powers of the Trustee

As the trust evolved over a period of time, it further encompassed broader discretionary powers given to the trustee in making distributions to beneficiaries.

First, it was deemed that if the income from the trust was not sufficient for the needs of the life beneficiary, the trustee could invade principal for the income beneficiary. This provision often times, but not always, contemplates that the trustee exercise due diligence in evaluating the needs of the income beneficiary in whatever standards, such as health, education, maintenance of standard of living provisions which might be the guiding light to the trustee.

Later when it was deemed that the income may be more than the income beneficiary needs, the trustee, in exercising its discretion, could distribute income to the primary beneficiary but also, for example, to a widow’s three children and retain some of the income in a trust. Therefore, there would be five income tax payers: the widow, the three children and the trust itself. This would breakup the income and the resulting income tax for the benefit of all concerned, likely across varying tax brackets.

Even later, provisions have been included to allow the trustee, at its sole discretion, to terminate the trust if the trustee deems the trust to be no longer economically or practicably feasible.

Trusts are created to also help grantors assure that their intent is followed and help the beneficiary understand their future role of preserving and providing for future generations. The modern-day trust is a flexible and viable instrument that requires objective judgment and empathetic understanding of all factors and individuals involved.

Nonetheless, the trustee has a general duty to administer the trust in good faith according to its terms and the laws governing the trust.

You should consider the responsibilities of the trustee in creating a trust and empowering the trustee with discretion on distributions of principal and/or income. It is not an easy task. It requires objectivity, experience and intent to be fair to all concerned.

Disclosures

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the Funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.

There are risks involved with investing, including loss of principal. Current and future portfolio holdings are subject to risks as well. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise. High-yield bonds involve greater risks of default or downgrade and are more volatile than investment-grade securities, due to the speculative nature of their investments. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.

Diversification may not protect against market risk. There is no assurance the objectives discussed will be met. Past performance does not guarantee future results Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index.