Trusts are established with different criteria and personalized to the specific needs of the grantor. Some trusts may terminate soon after the death of the grantor, while others may not.

In all situations, trust assets must be managed by the trustee or successor trustee in the best interest of the beneficiaries or remainder beneficiaries who are entitled to the assets when the trust terminates.

A trustee is a person or entity given control or powers of administration of the property in a trust with a legal obligation to administer it solely for the purposes specified. A beneficiary may receive income from the trust, the final distribution, or both.

When a remainder beneficiary is designated, he or she is entitled to receive the trust principal after the need to provide income to the beneficiary is no longer required. At that point, the trustee transfers the amount remaining in the trust to the remainder beneficiary.

Considerations for trust investments

One of the basic rules of trust administration is that the trustee must act as a prudent investor. The prudent investor rule means that when the trustee is given control over another’s assets, they must make investment decisions that a person of reasonable intelligence, discretion, and prudence could be expected to make. That means choosing investments that do not increase the risk of loss. The trustee must only invest clients’ funds in ways that could reasonably be expected to perform well.

Factors to consider:

— Portfolio diversification: Is the allocation appropriate for the trust’s objectives? A portfolio that will terminate within a short period should not be invested in a high-risk allocation. Or the converse: A trust with many years to its life, should not be invested all in cash or a very low yielding investment strategy. The allocation should be determined by the timeline the trust will be in place.

— Account titling: Was the account opened under the correct titling? Sometimes accounts are opened with incorrect titling, confirm the titling is accurate to eliminate future problems.

— Conflicts of interest: Are you trustee and beneficiary?

— Portfolio rebalancing: Is the portfolio being rebalanced regularly? Portfolios need to be rebalanced at least annually. Otherwise, the allocation will change due to market performance over time and may not meet your original intentions.

— Investment performance: How are the investments within the portfolio performing? Don’t just assume an investment will aways perform as expected. At least annually, research the investments to determine if they are outperforming or underperforming their peers. When you are in a selling position, realize that there may be income tax ramifications and understand how the capital gain or loss will affect future tax returns.

— Investment restrictions: Are there investment restrictions that need to be addressed in the portfolio allocation, such as, ethical, environmental, social and governance screens?

— Diversification: Are there other significant assets held by the beneficiaries or their families that should be acknowledged prior to allocating the investment portfolio? If you are managing trust funds that are heavy in a specific asset class, such as real estate, then intentionally do not include more real estate in the investment portfolio.

— Frequency of distributions: Is cash available to fund distributions? If you need to pay out income on a regular basis, consider opening an additional investment account to capture the dividends and interest over the course of a month, quarter etc. At the end of the period, transfer the income to the beneficiary.

— Portfolio risk: Does the risk align with the timeline for future distributions?

— Investment objective: What is the objective of the portfolio, asset preservation, income, or growth?

A trust can hold a variety of different assets, including stocks, mutual funds, exchange-traded funds, real estate investment trusts, businesses, municipal bonds, real estate, cash, and other property. Successful investing often requires a careful and objective weighing of several factors by the trustee.

Are the beneficiaries relying on the trust income to supplement their income? Do the assets in the portfolio need to grow to be distributed later? It is important to understand if the trust is growth-oriented, income-producing, or both growth-oriented and income-producing. The balancing act could be between growing the trust assets for the remainder beneficiaries while providing an income stream to the current beneficiaries.

The trustee or investment manager should allocate the portfolio to address the instructions of the trust they are managing specific to the needs of the beneficiaries. If the trust is paying out dividends monthly, quarterly, or annually, then a process should be implemented so the distributions are paid to the beneficiaries in a timely manner.

Minimizing taxes is another key duty for the trustee. A trust must file tax returns and report the income from its investments to the Internal Revenue Service and Franchise Tax Board on any qualified dividends, income, rental income, or capital gains annually. When a trustee makes a trust fund distribution of income to beneficiaries, the beneficiaries will then need to report the income on their personal tax returns. The trustee should complete the trust tax returns and provide a K-1 tax form 1065 in a timely manner to the beneficiaries. This K-1 is specific to trusts and distinguishes between how much of the trust distribution is from trust principal and how much is from trust income.

Given the duty to factor in taxes, understanding the difference between short- and long-term gains and losses is key. Because long-term capital gains tax rates are lower than short-term tax rates, which are taxed at the ordinary income rates, the trust assets should be managed with this in mind. When possible, trustees should take care to avoid short-term gains.

Portfolio management should also include tax-loss harvesting. Tax-loss harvesting is the process of selling positions at a loss, offsetting them against embedded gains within the portfolio so that there is no net taxable gain to be recognized when tax returns are filed for the year. When the market is down, such as we are experiencing now, the investments should be reviewed to determine if this strategy should be implemented.

Serving as trustee is a position that should not be taken lightly. You were placed in a trusted position often by a beloved family member or friend. You owe the highest duty of loyalty to the beneficiaries to administer the trust solely in their best interests. If this task becomes too burdensome, remember there are professional fiduciaries who are experts in this field who can help.

Teri Parker is a vice president for CAPTRUST Financial Advisors. She has practiced in the field of financial planning and investment management since 2000. Reach her via email at Teri.parker@captrustadvisors.com

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