In many ways, managing a family pot trust is a bit like heading home for the holidays. A Google search for “holidays with family” results in over 646 million hits, with nine of the top 10 articles offering tips on managing conflict. Now imagine those same family dynamics but instead of everyone sharing Thanksgiving dinner, they are sharing a pool of money.
Pot trusts, which allow a trustee to sprinkle distributions among a class of beneficiaries, are often touted for their flexibility regarding distributions, potential to shift income from higher to lower tax brackets, broader investment opportunities, and reduced administrative costs compared with multiple smaller trusts. However, administering a pot trust is rarely straightforward. The trustee often must manage tricky family dynamics and competing interests. Long-simmering family dynamics can boil over when the beneficiaries have disparate expectations and objectives. Clear guidance in the trust instrument is critical.
Managing the Pot Trust
When managing a pot trust, the trustee must be mindful of fiduciary duties to all beneficiaries. Among the most important are the duties of impartiality and to inform and account. Impartiality requires a trustee to treat beneficiaries equitably, if not equally, in accordance with terms and purposes of the trust. A trustee cannot favor one beneficiary or class of beneficiaries over another unless expressly authorized under the instrument.
The duty to inform and account requires that a trustee disclose certain information regarding the trust’s existence, terms, assets, distributions and expenses to the beneficiaries who are entitled to such information. SCPA 2309. Failure to do so at least annually may result in the denial of commissions. Although a trustee may sometimes be pressured by the senior generation of beneficiaries to limit information given to the broader class, the trustee must communicate with all the beneficiaries or face potential claims of breach of duty.
Difficulties with Distributions
“Often, cases that test the limit of a trustee’s discretion are those that involve trust provisions for the discretionary distribution of trust principal.” Matter of Goodman¸ 2015 NY Slip Op 31234(U) (Sur. Ct. NY County 2015), affd., 149 A.D.3d 649 (1st Dept. 2017).
Whether distributions are authorized in the trustee’s “absolute discretion” or are limited by an ascertainable standard, a statement of the grantor’s intent helps guide the trustee in exercising these powers. For example, the trust may provide that the trustee is encouraged to exercise discretion liberally, or that trust assets be used to only to supplement but not support a beneficiary’s lifestyle.
Confusion regarding priority among beneficiaries is all too common. A trustee may be authorized to make unequal distributions but beneficiaries may expect to be treated equally. More common in a pot trust is the beneficiary who expects, or needs, more than an equal distribution. A grantor who intends to favor a particular beneficiary or class of beneficiaries should express their intentions in the governing instrument. Even then, the degree of preference may be open to debate.
Differing perceptions of “fairness” may become an issue. Even when the trust has a defined purpose (e.g., an education trust for grandchildren) differences in ages among a large class can result in unequal distributions simply because of rising costs. Beneficiaries’ differing economic positions and lifestyle choices may also make it difficult for a trustee to exercise discretion tied to a beneficiary’s “health, support, maintenance and education,” particularly when those terms are modified by reference to a beneficiary’s “lifestyle,” “comfort” or “standard of living.” The trustee must balance one beneficiary’s need for support with the interests of beneficiaries who have other resources available to them.
Ideally, the trust instrument will specify whether the trustee should consider a beneficiary’s other resources. When the instrument is silent, the law is unclear. One view is that a trustee may not consider a beneficiary’s other assets unless specifically authorized under the governing instrument. The more modern trend, embodied in the Restatement (Third) of Trusts, is that outside resources should be considered unless the document provides otherwise. There is also authority for taking the position that if the trustee’s exercise of discretion is predicated on a finding of the beneficiary’s need, then outside resources should be considered. Matter of Martin, 269 N.Y. 305, 199 N.E. 491 (1936).
Fixing a Broken Pot Trust
At some point, the pot trust may become unworkable.
State law authorizes a trustee to divide (EPTL 7-1.13) or decant (EPTL 10-6.6) a trust under certain conditions. Further, a trustee may be granted broad decanting, division or other modification powers in the governing instrument. Regardless of the source of authority, a trustee must consider whether the proposed exercise of those powers is in keeping with the trustee’s fiduciary duties. New York courts that approved either the division or the decanting of the original pot trust offer some guidance.
Division of Trusts
Disparity in the needs of the class of beneficiaries and a desire to maintain family harmony were cited by the court in Matter of Warnecke, 2018 NY Slip Op 30005 (U)(Sur. Ct. New York County 2018) in granting the application of the co-trustees of a testamentary trust for permission to split the trust into two separate trusts along family lines. The facts showed significant differences among beneficiaries and that, because of the age and number of the beneficiaries in one family line, disproportionate distributions had been made. In approving the division, the court dismissed the concerns of the guardian ad litem for the minor grandchildren, noting that the trust had ample assets and that the potential for unequal distributions would not violate the primary purpose of the trust.
A similar result was reached in Matter of Rutgers, NY Slip Op 32863 (U) (Sur. Ct. New York County 2014) where the court held that the risk that the beneficiaries would have access to smaller pool of funds following the proposed trust division was outweighed by the beneficiaries’ different investment goals and needs. A contrary result was reached in Matter of Michaelian, NYLJ Nov. 7, 2011 at 18, col 3 (Sur. Ct. New York County 2011) where the court cited the relatively small size of the trust in denying a petition to divide a trust where the governing instrument expressed the grantor’s intent that the entire trust fund be available to any beneficiary who might have need.
A proposed division that would result in a material change to the distribution plan upon termination will not be permitted if the court finds such plan to have been a primary purpose of the trust. In Matter of Fussell, 821 N.Y.S.2d 733, 34 A.D.3d 164 (4th Dept. 2006) the Appellate Division overturned the Surrogate’s Court decision dividing a trust into per stirpital shares, finding that the division would disproportionately benefit one side of the family in contravention of the grantor’s intent. Similarly, in Matter of Brody, 21 Misc.3d 1108, 872 N.Y.S.2d 689 (Sur. Ct. Nassau County 2008), the court refused to order the proposed division of a trust with complex cross-remainder provisions into separate shares because the requested relief could not be achieved without changing the distribution plan.
Decanting a Problematic Trust
Decanting is another tool for fixing an unworkable pot trust. Common reasons for decanting include income tax savings, administration and trustee succession efficiency, and to extend the trust term.
May a trustee properly exercise a power to decant a trust so as to remove one or more beneficiaries without giving notice and an opportunity to object as is required by statute? That was the result in In re Hoppenstein, 2017 NY Slip Op 30940(U) (Sur. Ct. New York County 2017) where the court approved the exercise of a decanting power granted under the trust instrument as opposed to under the statute. Noting that EPTL 10-6.6(k) specifically provides that the statute shall not constrict any right of appointment that arises under the governing instrument or common law, Surrogate Rita Mella held that statutory compliance was “immaterial.”
The court was later called to determine whether the decanting was a breach of the trustee’s fiduciary duties and was unequivocal in its findings. Citing trustee’s broad absolute discretion, the court determined that the distribution complied with both the terms of the trust and the settlor’s intent. Matter of Hoppenstein, 2017 NY Slip Op 32113(U) (Surr. Ct. New York County, October 10, 2017). Both lower court decisions were recently upheld. Matter of Davidovich v. Hoppenstein, 2018 NY Slip Op 04442, 162 A.D.3d 512 (1st Dept. 2018).
What actions may be taken to make managing a pot trust less perilous?
• If outside resources are considered, request a budget, income tax returns and other such information from all beneficiaries within the class. Such information would enable the trustee to develop a clear understanding of the needs of the various beneficiaries.
• Keep a running tally of distributions made to the various beneficiaries. This will enable a trustee to maintain a sense of whether the beneficiaries are receiving equal benefits (if consistent with the grantor’s intent) and to identify a quiet beneficiary whose interests may be overlooked.
• Plan ahead for future expenses to ensure that the trust will have sufficient assets to enable beneficiaries of different generations to receive the same benefit (measured in terms of achievement of the goal and not in dollar amounts).
• Proactively communicate with all of the beneficiaries directly.
• Be consistent in the provision of information to all current income beneficiaries and discretionary/remainder beneficiaries who would be entitled to such information (including account statements) upon request.
• Consider whether division or decanting would be consistent with the terms of the governing instrument and in keeping with the trustee’s fiduciary duties to the current and remainder beneficiaries.
• Document all communications with beneficiaries and decisions. A trustee may be wise to manage the trust in the expectation that future litigation is always a risk.
Elisa Shevlin Rizzo is Senior Fiduciary Officer and Senior Legal Counsel at Northern Trust Company in New York.