People often place sums of family money, ranging from modest to large, in trusts. The idea of a trust is to give the money some legal protection from misuse, getting into the wrong hands and from certain forms of tax liability. Another major objective is to keep the money in custody for one's children, or for some other charitable or specific purpose. (This arrangement allows you to have more control over your estate - both before and after your death. For more, see Establishing A Revocable Living Trust.)
TUTORIAL: Estate Planning

Not surprisingly, trustees who are entrusted with the assets are both legally and morally obliged to look after it as if it were their own and to care about those who have provided the funds and those who are to benefit now or in the future. Unfortunately, such expectations may be disappointed. There are many cases of trusts being actively mismanaged or apathetically unmanaged. The one thing you can be sure of is that they are complex vehicles that cost money to run. (For related reading, see Encouraging Good Habits With An Incentive Trust.)

In this article, we will look at some of the specific problems and how to prevent them arising in the first place.

Common Problems Associated with Family Trusts
Firstly, one of the fundamental duties of the trustee is to ensure that the money is properly diversified and remains so over time. Even though this is not much trouble at the base level, many trustees just do not bother. The trustee is often not particularly interested in the investments, even though they should be. This can have disastrous consequences. Trustees can and have been sued for leaving everything in equities, which is far too risky, or for the exact opposite reason. An all-cash portfolio is hopelessly unproductive, even in the medium term, and too many bonds can also be a bad idea. There is no shortage of instances in which beneficiaries have suffered appalling losses or lost profits from such extreme and dysfunctional portfolios.

Once the trust has been set up, the trustees are vested with a degree of discretionary power, which may be abused. A trust inevitably entails a shift of power and control, which is not always a good thing. This may not seem a problem, especially in the beginning, but as time passes and the situation changes, trustees have been known to emerge from hibernation and make life rather difficult.

The trustee can exert unpleasant and undue pressure on the beneficiaries and may be difficult to deal with. For instance, if a couple establishes the trust when they are fit and well, the situation changes if one dies and the other has Alzheimer's. The children who are beneficiaries may find themselves in the clutches of the trustees, who are more interested in protecting and enriching themselves, rather than the beneficiaries. (For related reading, see Can You Trust Your Trustee?)

In general, but especially for relatively small trusts, the fees may turn out to be very heavy, with every little thing being charged for. The beneficiaries may be shocked to find each request for information, each and every email and transaction draining the funds bit by bit. Again, this may not happen right away, but down the line when the original circumstances no longer apply.

Furthermore, the accounts may be opaque and reveal too little about what is being deducted and why. To compound the problem, the investments themselves cost money to run, so there are now two layers of fees.

Yet another problem is that of administrative and legal complexity. Trust deeds and the associated laws mean that the money is tied up in two layers of bureaucracy and red tape. And if there is mismanagement, who do you sue? The trustees or the fund managers or both? If these two parties concede anything at all, it is likely to be that the other party was negligent, but not them of course. Even worse, if they are not both in the same country or state, the chaos may render any action extremely difficult. (For related reading, see Three Documents You Shouldn't Do Without.)

How to Prevent These Problems
If you are thinking of setting up a trust, you need to do a lot of homework. Find out if a trust is really the way to go, or if there is some simpler and cheaper alternative. If a trust does seem right, find people who are worthy of the name. In other words, do you really need a trust? Look carefully at your objectives and what you want to achieve.

You need to know exactly what the trustees will and will not do with the money and for the beneficiaries. Ask them how much experience they have in dealing with such investments and how exactly they will manage and monitor it. How often will this be done and what will they do to ensure that it is invested correctly? Will they provide a report and an analysis, for instance? Ask for samples of their work and references.

Regarding fees, find out the balance between regular fixed charges and variable ones. The latter are particularly dangerous, because they are relatively unpredictable. If there is some problem with the trust, you may find that they suddenly charge you three times the fixed fee for administration, legal fees and other charges. You need a clearly itemized account that is totally transparent. If the package seems very expensive, ask if they can offer a simpler arrangement that costs less, or if the fee structure is flexible. If they want your business, they may be willing to reduce the charges. The time to clarify all of this is before entering into the agreement. (For related reading, see Getting Started On Your Estate Plan.)

And how you can get out the arrangement if you need to? It is important to be able to extricate yourself without excessive barriers or costs. Again, ask the potential trustees to be very clear about all this – and in writing.

Another potential problem is a change in trustees if the original firm goes out of business or gets taken over. You need to know how you will be affected by such changes. After all, a trust is generally a long-term arrangement.

Given these potential problems, it is worth shopping around to find the right people. There is considerable variation in the nature of service that trustees can and will provide.

You should almost certainly go to an independent lawyer or advisor, who can tell you what will fit your needs. This person needs to understand that he will not get the job of setting up the trust, and that all you need is a second, entirely objective opinion. It is really worth spending this time and money to make sure. (For related reading, see An Estate Planning Must: Update Your Beneficiaries.)

The above can be pretty daunting, but you need to go into a trust with your eyes wide open and no illusions. If you are not willing to do all this, or the potential trustees are not, you are probably best off walking away.

Trusts can serve a useful, even indispensable purpose. In many instances, they are extremely valuable in providing legal and administrative protection, and ensuring that the money is used for the intended purpose. But they are sometimes truly not necessary, or are just too expensive and complex.

It is therefore vital to set them up right, and ensure that they meet their objectives over the full time horizon without being prohibitively complicated, unwieldy or riddled with fees. (For more related reading, see Establishing A Revocable Living Trust.)

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