TRUSTS AND TRUSTEES



A trust is a tool that an individual or institution uses to transfer property to a beneficiary. The party that grants the property is called the trustor. The trustor gives the property to the trustee, who, in turn, is charged with the task of disbursing the property to the beneficiary according to the instructions of the trustor. As of 1997 U.S. banks managed an estimated $3.3 trillion in discretionary trust assets, or assets banks control as trustees, according to reporting by federal oversight agencies.

One important advantage that a trust has over a simple gift is that the trustor can exercise control over the disbursement of funds or property over time, even after his or her death (or dissolution, in the case of an institutional trustor). For example, a trustor may stipulate that funds periodically transferred to an all-female academy must be terminated if the school begins enrolling males. A second, and perhaps more important, advantage is that trusts can be used to minimize tax burdens incurred when transferring wealth.

The two main categories of trusts are non-charitable and charitable, they are differentiated from one another primarily by tax status. Charitable trusts are organized for nonprofit beneficiaries, such as educational, religious, and charitable organizations. Examples of major charitable trusts include the Ford Foundation and the Pew Charitable Trusts. Beneficiaries of noncharitable trusts typically include individuals or groups—particularly relatives or employees of the trustor—or profit-seeking organizations. Examples include pension and investment funds and personal estates.

Most trustees in the United States are banks' trust departments. However, other types of financial institutions act as trustees, and some companies specialize in trust management. Firms in the latter category are sometimes known as independent trust companies. Furthermore, for very large trusts, such as those created through corporate philanthropy, the trustees are separate entities that have been set up as foundations (e.g. Ford Foundation, Lilly Foundation, Wal-Mart Foundation) to manage the trust funds.

HISTORY OF TRUSTS

Trusts date back to about ancient Egypt, circa 4000 B.C., when the equivalent of today's trust officers were charged with holding, managing, and caring for other people's property. Various prototypes of trust institutions were later developed in second-century Rome, some of which involved the use of property for charitable purposes. Trusts began to evolve into their present form during the eighth century, when English clergymen acted as executors of wills and trusts. Throughout the Middle Ages and into the 17th century, trusts developed under English common law to resemble their current legal structure in the United States.

Legalized trusts began in the United States in 1822, when Farmer's Fire Insurance and Loan Company of New York became the first institution chartered in the trust business. Corporate trusts developed in 1830 to help raise money for new business ventures. During the next half century, the number and types of institutions engaged in the trust business rose rapidly. Most of these entities maintained a separate department devoted exclusively to trust services.

In 1906, Congress enacted laws that allowed banks to act as trustees, resulting in approximately 1,300 such institutions offering trust services by 1920. After the Great Depression, many trustees were prevented from conducting business by legislation that essentially restricted institutions other than banks and trust companies from serving as trustees. Legislation also established what became known as the "Chinese Wall," which refers to measures that forbade bank trust departments from sharing customer credit or investment information.

The Depression also helped change American attitudes about saving and investing, and consequently, trusts. Employee benefit trusts, for example, became popular in the 1940s and proliferated so rapidly, that Congress enacted the Employee Retirement Income Security Act of 1974 (ERISA), to define the responsibilities of trustees managing such funds. By 1980, more than 4,000 banks, along with hundreds of trust companies, were managing $229 billion in employee benefit trusts. In 1986, employee benefit trusts represented over 40 percent of all U.S. trust assets.

Investments in individual and charitable trusts also escalated after the Depression. Wealthy individuals, in particular, increasingly used trusts as a way to invest their savings and to transfer wealth. Increases in tax benefits that allowed trustors to avoid estate and gift taxes boosted the utilization of trusts.

In the late 1970s and early 1980s, due to a number of economic and regulatory influences, trusts began to change. High interest rates and the deregulation of certain sectors of financial markets, for instance, prompted trust departments to invest their assets in a multitude of new instruments. Instead of traditional T-bills and commercial paper, trustees began investing money in certificates of deposit, money market funds, variable-rate notes, and other options many analysts deemed risky. (Ironically, these investment vehicles are quite conservative by today's standards, to the extent that many bank trust departments seek to shed their conservative image.) In addition, a strong economy in the mid-1980s generated an influx of investment in trusts, much of which went into charitable trust funds. Between 1980 and 1986, the total amount of money invested in trusts jumped from $571 billion to $1.07 trillion.

Although assets under trustee management continued to climb through the mid-1980s, trustees faced a variety of setbacks in the late 1980s. The Tax Reform Act of 1986, for instance, increased costs and paperwork, and created some confusion for trustees, the end result of which was to discourage the use of trusts and estates as devices to accumulate and transfer wealth. Investment in trusts slowed in the late 1980s and early 1990s. Between 1987 and 1989, the number of trustees in the U.S. decreased from 6,285 to 4,283, and total employment by those trustees fell from 32,491 to 25,853.

TYPES OF TRUSTS

Several different kinds of charitable and noncharitable trusts are legally recognized. Generally, they all serve the same basic function, which is to transfer wealth from the trustor to the beneficiary(s) by means of a trustee. In addition to transferring wealth in the form of dollars, trusts may also include the following gifts: income-producing property, business inventory or equipment, securities, life insurance, works of art, real estate, or jewelry.

NONCHARITABLE TRUSTS

INDIVIDUAL TRUSTS.

Noncharitable trust accounts that banks and trust companies manage are categorized as either individual or institutional (corporate). Individual accounts can be further classified into personal agencies or trusts. Personal agency accounts are different from ordinary trust accounts in that property does not actually change hands. Instead, the trust company simply manages assets under the direction of its client, often acting as a safekeeping agent, custodian, manager, or escrow agent. The company may provide complete investment management and reporting services as well.

In contrast to personal agencies, individual trust accounts involve a beneficiary. The trustor establishes an account with a trustee that manages, invests, and distributes the property. Income from the assets is then used to benefit dependents, organizations, or other parties. The trust may also be used to indirectly benefit the trustor. Many trust structures allow trustors various tax benefits and varying degrees of control over account assets.

Two types of individual trusts are guardianships and estate settlement accounts. In the first category, the trustee acts as a guardian to a minor or mentally incompetent individual, caring for the property that benefits that person. Estate settlements, on the other hand, involve securing and valuing a client's assets, distributing assets in accordance with a will, and representing the client's wishes at death.

Individual trusts are also classified as either revocable or irrevocable. Revocable trusts are used to distribute wealth while the grantor is alive, and can be amended at any time. In an irrevocable trust, the trustor relinquishes all control over account assets.

INSTITUTIONAL TRUSTS.

Like individual trusts, institutional (or corporate) trusts can be divided into agency and trust accounts. Institutional trusts, though, exist to raise capital for businesses, to reward employees, or to provide income for retired employees. The two most common types of corporate agencies are transfer agencies and registrarships. Trustees in agency relationships simply serve to transfer and register stocks and bonds.

In a corporate trust, the trust company acts as a trustee for a group of people who have lent money to a corporation through bonds or other obligatory instruments. Employee benefit accounts are another form of corporate trust. These trusts provide full custody services, compliance reporting, investment management, and special record keeping for each participating employee's interest in pension, profit-sharing, and other benefit accounts.

CHARITABLE TRUSTS

Donors may use a variety of trusts to transfer wealth to nonprofit causes. Each type of trust offers different advantages regarding the amount of control the trustor may exercise over the gift, various tax benefits that accrue to the trustor, and the method of compensation bestowed upon the beneficiary.

Charitable trusts, as opposed to all other forms of trusts, are usually enforced by the U.S. government. Furthermore, the entire trust industry is closely regulated by the U.S. government. For example, beneficiaries may reclaim property if trustees violate their fiduciary duty (or trust) by making unlawful or reckless investments.

The charitable remainder annuity trust (CRAT) periodically distributes a fixed amount of property to noncharitable parties—often the trust's grantor. After the recipient(s) die, the remainder of the CRAT passes to a charitable organization. Among other advantages, the CRAT allows the grantor charitable income tax deductions equal to the present value of the remaining interest that will ultimately be received by the charity. These deductions are used to offset income from the trust during the grantor's life.

The wealth replacement trust is used in conjunction with a charitable gift. This technically complex type of trust is used to replace assets given to a charity, while benefiting specific noncharitable parties—often the grantor's family members. The grantor may receive valuable tax benefits related to capital gains, gift, and estate taxes. Survivors of the grantor's estate typically benefit from reduced inheritance taxes.

Charitable lead trusts distribute income to philanthropic entities for a fixed term. At the end of the term, the remaining trust is transferred to a noncharitable beneficiary, such as a spouse or child. A benefit of a charitable lead trust is that the grantor avoids estate taxes on the value of assets that defaults to the beneficiaries.

A pooled income fund is a trust maintained by a charitable organization. Each donor who transfers income to the pool may be eligible to receive significant income tax and gift-tax deductions, as well as estate tax benefits. Charitable gift annuities, which became popular in the 1980s, have similar donor benefits. This type of trust, however, is arranged so that grantors receive specified sum of money each year for the remainder of the donor's life.

Other charitable trusts include "bargain sales," in which donors sell property to charities for below-market prices, and "charitable stock bailouts," in which a donor contributes closely held stock to a charity, thereby deriving various tax and/or business benefits.

TRUSTEES

Although trust companies and banks expect to profit in their role as trustee, they have a legal responsibility to act in the best interests of both the beneficiary and the trustor, and to conduct their activities with skill and care. Responsibilities include:

Most importantly, the trustee is obliged to faithfully execute the wishes of the trustor. In return for their services, trustees are compensated by one of several methods. A common pricing schedule is a percentage of the market value of assets under management in a trust account. Under this arrangement, trustees typically charge from 0.1 to 0.5 percent, and in some cases as much as 1 percent per year of the total value of assets in the trust. For example, a $2 million trust fund might yield $5,000, or 0.25 percent, in annual fees.

Similarly, some trustees charge a "gross income receipts fee," which is a percentage of income collected from interest and dividends on the account. For instance, if the trustee earned interest and dividends of $50,000 by investing account assets for a period of one year, the trustee might receive 5 percent of those proceeds, or $2,500 dollars. In addition to these charges, some trustees also charge minimum annual management fees or activity fees for special services.

For many financial institutions, fees from trust services are a major revenue center. Government data indicate that in 1997 U.S. banks took in approximately $23.8 billion in fiduciary income derived from commissions and other fees for managing trust account assets. When banks' $19.7 billion in management expenses that year were deducted, they were left with $3.9 billion in operating income, or a comfortable 16 percent net operating margin. The two largest fee categories by account type are personal/estate trusts and general agency accounts. These two groups were responsible for more than half of all bank fiduciary income in 1997. The largest expenses involved in operating a bank trust department are typically staffing costs, including salaries and benefits, which may account for anywhere from a third to more than half of all trust management expenses.

BUSINESS STRATEGIES.

In order to maintain profitability in trust operations, many banks impose minimum account sizes. Formerly only the largest regional and national banks had such policies. Emphasis on the bottom line, however, has impelled smaller banks to do likewise. Large banks, for example, might require that trust accounts be worth at least $1 million. As an alternative, some smaller banks have instituted steep minimum annual fees rather than specifying a minimum account size. Smaller banks may also stratify their service offering by account size, offering only minimal services for the smallest accounts (say, those under $100,000), and additional services for each successive asset bracket.

Conventional wisdom holds that small trusts demand an inordinate amount of resources for very minimal returns to the bank. By extension, for smaller banks it is generally not profitable to maintain a trust department if the total discretionary assets aren't of a certain magnitude; some industry veterans believe the minimum assets size should be in the $70 million to $100 million range.

Another strategy for bank trust departments has been to outsource various parts of the trust management process. The level of outsourcing can range from sending out routine and technical activities like transaction processing or accounting to bringing on board an outside firm to run the trust business entirely. Bank executives believe such approaches help control costs and allow the executives to focus on sales and customer service. Some of the largest outside services firms for trust-department outsourcing include SEI Investments Company, DST Systems, Inc., and UAM Trust.

LARGEST TRUST BANKS.

For personal trust accounts, the largest U.S. banks as of year-end 1997, as reported by American Banker, were NationsBank Corp., with 65,392 trust accounts and $126 billion in assets; Wells Fargo & Co., with 65,271 accounts and $62 billion in assets; and PNC Bank Corp, with 37,132 accounts and $38 billion in assets.

In the general institutional trust category, State Street Corp. was the largest bank based on 1997 figures, with over 40,000 accounts and $423 billion in assets. Some trust industry analysts rank State Street as the largest trust bank overall because of its asset size, but technically a few large commercial banks that administer corporate trusts have more in trust assets. Other general institutional trustee banks include Bank of New York, with 39,074 accounts; and Bankers Trust of New York, with 21,444 accounts.

[ Dave Mote ]

FURTHER READING:

Clarke, John M., Jack W. Zalaha, and August Zinsser III. The Trust Business. Washington: American Bankers Association, 1988.

Federal Financial Institutions Examination Council. Trust Assets of Financial Institutions - 1997. Washington, 1998. Available from www2.fdic.gov/structur/trust/ .

Fraser, Katharine. "Profit-Conscious Trust Departments Raising Account Minimums." American Banker, 6 October 1997. Luhby, Tami. "More Banks Outsourcing Their Trust Processing." American Banker, 6 October 1998.

Namjestnik, Kenneth J. The Trust Risk Management Manual. Chicago: Probus Professional Publishing, 1995. Nemer-Wilfong, Tara. "Bank Trust Departments Increasing Outsourcing." Trusts & Estates, October 1998.

Phillips, James A. "Think about Not Calling It a Trust Department." American Banker, 18 October 1996.

Shenkman, Martin M. The Complete Book of Trusts. 2nd ed. New York: John Wiley & Sons, 1997.

"Top Fiduciary Trust Accounts.' American Banker, 21 July 1998.



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