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07.27.21

Guidance to trustees in making distributions to trust beneficiaries

BY Deborah L. Anderson

There are many tax and financial advantages from establishing trusts for the benefit of your family, including your spouse, children, grandchildren, and others. One of the most important functions of a trustee is to make appropriate distributions to the beneficiaries of the trust. The terms of the trust should provide clear guidance or clear mandates to the trustee as to how and when to make distributions to beneficiaries. A trust may include specific factors to be considered by the trustee in making distributions.

Discretionary trusts

In a discretionary trust, the trustee has complete discretion in distributing income and/or principal to a designated beneficiary or a class of beneficiaries. There are no specific rules or standards. The settlor of the trust, however, could provide guidance. For example, the settlor may indicate that the trust is primarily for the benefit of one’s spouse versus one’s children or grandchildren. This type of trust is often favored because it protects the beneficiaries from their creditors, which could include divorcing spouses. Because the beneficiaries have no enforceable right to trust distributions, their creditors have no rights either.

Trusts using ascertainable standards

An “ascertainable standard” provides specific guidance to the trustee in making distributions to a beneficiary. The words in the specific guidance have been interpreted by state courts and by taxing authorities. Typically, the terminology used is a direction to the trustees to make distributions for a beneficiary’s “health, education, maintenance[,] and support,” or in some cases “support in reasonable comfort.” The theory is that because these standards could be reasonably determined by a third party, a beneficiary can petition a court to enforce the standard of distributions should the trustee be unwilling to make distributions in accordance with the standard. For example, a beneficiary can go to court and argue that the trustee is not making sufficient distributions for his or her support. Because a beneficiary can sue to enforce those ascertainable distribution rights, so can a beneficiary’s creditor.

The trustee in making distribution decisions must balance various factors including, but not limited to, the current and projected needs of the beneficiaries of the trust, the length of the trust, and the income, gift, and estate tax implications of distributions to the beneficiaries rather than retaining their interests in trust.

One advantage of using an ascertainable standard is that, under current tax laws, a beneficiary would be able to serve as the sole trustee or a co-trustee without subjecting the trust property to estate tax in the beneficiary’s estate.

Providing additional guidance to the trustee

In using an ascertainable distribution standard, the settlor should consider providing clarity and guidance regarding his or her intent and not rely solely on state law interpretations. For example, the settlor may desire to provide for the support of a spouse based on their standard of living at the time of the settlor’s death. In a long-term trust for the benefit of the settlor’s children, the settlor may wish to provide for increased distributions as the children change their standard of living from the time the trust was established. The settlor of the trust should consider providing guidance as to whether the trustees need to take into account a beneficiary’s income and assets outside of the trust in determining whether distributions are required for support of the beneficiary.

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Deborah L. Anderson

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