When my children were young, I used to read Dr. Seuss books to them. One of their favorites was The Cat in the Hat Comes Back. You may remember the plot where the devious cat causes pink spots all over the house while mother is gone. When the kids get scared that the mess can’t be cleaned up, the cat reveals one cat after another inside ever-decreasing sized hats one on top of the other, kind of like a Russian Matryoshka doll. All of the little cats cause an even bigger mess before eventually cleaning up before mother returns.
Wearing more than one hat can become a problem in an estate plan as well. An example of this is when someone is both a trustee for their deceased loved one’s trust and is also a beneficiary of that same trust. Let me give you an example.
Suppose that Thomas’ trust is held for the benefit of Isabelle, his second wife. Isabelle is to get income for the rest of her life, and if the income is insufficient for her needs, the trustee can invade the principal of the trust for her health, maintenance, and support. Upon Isabelle’s death, then the trust terminates back to Thomas’s children, Tim and Tom Jr.. Isabelle is not Tim and Tom Jr.’s mother. Isabelle is also the trustee of the trust.
Here Isabelle is wearing “two hats.” As trustee of the trust, she has a responsibility not only to her own needs – to provide herself income and possibly invade the principal of the trust for her own benefit – but she is also supposed to be watching out for the needs of the remaindermen beneficiaries – Tim and Tom Jr.. It appears that Isabelle has a conflict of interest, which is quite common in these scenarios.
A trustee would have to balance the investments for both income (which benefits Isabelle) and growth (which benefit Tim and Tom Jr.). As a beneficiary, Isabelle would want to weigh the investment portfolio to maximize the income earned so that she has more money to spend every month. But when a trustee invests for income, that is usually at the expense of growth. Tim and Tom Jr. want the trustee to invest for growth, since they want the trust to increase in value during Isabelle’s lifetime, if not only to keep pace with inflation.
Keep in mind that every dollar that Isabelle spends – especially principal dollars of the trust – is one less dollar that Tim and Tom Jr. will one day receive as inheritance. Even if Isabelle has a loving relationship with her stepchildren, legally she and they have adverse legal interests. What they will want from the trust is in direct conflict.
Isabelle, therefore, is vulnerable. If she acts too much in her own favor, then Tim and Tom Jr. could sue her for breach of her fiduciary duties. What if Isabelle has a true medical emergency and invades the principal of the trust for many thousands of dollars? The trust seems to indicate that this is okay, but would your opinion change if Isabelle had millions of her own outside of the trust?
This is where good drafting comes into play. The trust could read, for example, that when making principal distributions the trustee should consider the other income and resources available to the beneficiary. It may also read that the trustee is to favor the income beneficiary’s needs over those of the remaindermen, or vice versa. It’s not a bad idea for the grantor of the trust to direct his attorney to write an “intent” clause:
“It is my intent that the trustee first consider the needs of my wife should she survive me, over the needs of my children, even to the extent of the exhaustion of the trust funds. In making these decisions, however, my trustee shall consider the outside income and resources available to her,” for example.
Yet another good idea is to name an independent party as a co-trustee to weigh in on investment and distribution decisions. This may serve Isabelle well, by taking some of the responsibility off of her shoulders.
There are many ways to “skin the cat” in this type of situation. A “standard” trust that does not delve into the grantor’s priorities and intent could actually cause more problems than it solves.
