Chapter 4 - Trusts, Trustees, and Other Fiduciaries and Powers of Appointment

Question 1

Legal definition of trust

Answer 1

A trust is a legal relationship in which one acts in a fiduciary capacity with respect to the property
of another.

Question 2

There are five elements common to all trusts:

Answer 2

Trust Elements
• creator (grantor/settlor/trustor)
• trustee (legal title)
• property (corpus/principal)
• beneficiaries (beneficial title)
• provisions/terms

Question 3

Trust Term Provisions

Answer 3

Usually, the trust terms are embodied in a written instrument called the trust instrument, deed of trust, or indenture of trust. The trust terms or powers are derived from those specified in the trust instrument as well as from the law of the jurisdiction in which the trust is situated and under which it is governed.

The trust terms include a set of powers, usually administrative, that may establish the scope of both the responsibilities and duties of the respective parties. The trust terms may also place limitations and restrictions on the trustee’s powers.

Question 4

Legal Limitations on Trust Duration

Answer 4

A perpetuity is any limitation or condition that takes away or suspends a person’s power to alienate property for an extensive or infinite time period. Therefore, the rule against perpetuities regulated the creation of future interests in trusts and requires
that for the trust to be valid, an interest in property has to take effect within a prescribed
time period.

Question 5

Alienation

Answer 5

Alienation is the right to sell, give away, or

dispose of property at will.

Question 6

Rule against accumulations

Answer 6

Another historic common-law rule, called the rule against accumulations, states the period during which income may accumulate. It was enacted using the same principle as the rule against perpetuities, and, in most cases, the permissible period during which the interest must vest is the same as under the ruleagainst perpetuities. There are a few states that have shortened the period for accumulations. Certain states permit accumulations today only for charitable purposes or during a child’s minority.

Question 7

Revocable Living Trust

Answer 7

A living trust (inter vivos trust) is created and operates before the death of the settlor. A revocable living trust is created when the grantor transfers the trust property to the trustee but reserves the power to alter or terminate the arrangement and reclaim the trust property.

Question 8

Irrevocable Living Trust

Answer 8

A living trust may also be established as an irrevocable trust by the grantor. In this case, the property is transferred to the trust permanently, and the grantor cannot terminate the trust and reclaim the property before the trust terminates by its terms. As we will discuss later, a truly irrevocable trust is treated as a completed gift for gift, estate, and income tax
purposes.

Question 9

Testamentary Trusts

Answer 9

A testamentary trust is created under the will of a testator. As such, it is never irrevocable until
the testator’s death or permanent legal incapacity.

Question 10

cy pres (pronounced see-pray)

Answer 10

A doctrine of law known as cy pres (pronounced see-pray) was developed to prevent the failure of trusts that cannot be applied to their original charitable purpose. A court may enforce a trust that has a general charitable intent. When applying cy pres, the court
attempts to find another charitable purpose similar to the initial charitable intention of the trust settlor. Cy pres may be applied when the initial charitable trust does not provide enough property to meet its purpose, or when the trust purpose has already been accomplished or becomes impossible, and additional funds remain in the trust.

Question 11

General Power of Appointment

Answer 11

General Power of Appointment
There is an unlimited right to appoint property to:
• yourself
• your creditors
• your estate
• your estate creditors

Question 12

Special Power of Appointment

Answer 12

With a special power of appointment, the donee of the power cannot be a direct appointee of the property.

Special Power of Appointment
Property may not be appointed to:
• yourself
• your creditors
• your estate
• your estate creditors

Question 13

Fiduciary Duties

Answer 13

Fiduciary Duties
• Be loyal to the beneficiary.
• Act for the benefit of the beneficiary.
• Do not delegate responsibilities that the fiduciary is able to perform (Uniform Prudent
Investor Act allows delegation).
• Disclose facts affecting any transaction.
• Preserve investment assets for the beneficiary.
• Make assets productive.
• Do not self-deal.
• Be impartial toward income beneficiaries and remainderpersons.

Question 14

prudent-person rule

Answer 14

In making investments of trust funds, the trustee is under a duty to the beneficiary (a) in the absence of provisions in the terms of the trust or a statute otherwise providing, to make such investments and only such investments as a prudent person would make of his own property having primarily in view the preservation of the estate and the amount and regularity of the income to be derived; (b) in the absence of provisions in the terms of the trust, to conform to statutes, if any, governing investments by trustees; and (c) to conform to the terms of the trust
(except under certain specified conditions).

Question 15

State Investment Powers

Answer 15

State Investment Powers
• prudent-person rule
• mandatory legal list
- Trustee investments are limited to a state-prescribed list.
- Nonlist investment is a breach of trust.
- The trustee is liable to beneficiaries.
• permissive legal list
- The trustee may invest in nonlist investments.
- The burden is on the trustee to show proper investment.
- There is no breach of trust for listed investments.
• Uniform Prudent Investor Act

Question 16

Guardian of property and person

Answer 16

Guardian of property
The guardian of the property pertains to the care and management of the ward’s property, it is purely a business relationship for which the guardian generally receives a fee for services.

Guardian of person
A guardian of the person usually is given funds from the guardian of the property to take care of the minor or incompetent individual.

Question 17

Guardian ad litem

Answer 17

A guardian ad litem, is appointed by the court for a particular purpose, generally to defend a specific lawsuit or legal proceeding in which the minor is a party. This type of special guardian is discharged by the court when the legal issue is resolved.

Question 18

Guardian de son tort (testamentary guardian)

Answer 18

A parent may name a guardian of his or her minor children in a will. Unless there is good reason to override this choice, the court usually honors it and appoints that person, called a testamentary guardian. The natural guardians of a child are the parents. However, courts in many states may not name the natural parent as guardian of the property of a minor. If the minor is old enough, a guardian may also be elected by the minor child. In some states, a minor over age 14 or 15 may choose his or her own guardian, who will be appointed unless there are reasons not
to do so.

Question 19

Guardian de son tort (of his or her own wrong)

Answer 19

Occasionally, a person assumes a guardianship of a minor or incompetent individual without seeking or obtaining court approval. This type of guardian is called a guardian de son tort (of his or her own wrong). Because this type of guardian assumes these responsibilities, he or she is held fully responsible for all acts performed as a guardian.

Question 20

Spendthrift Clause

Answer 20

A spendthrift clause is a provision in a trust - most trusts contain one - that prevents a trust beneficiary from using a future distribution to secure credit. The clause also prohibits payment to a creditor if it extends credit to a beneficiary based on future distributions.

Question 21

A trustee receives powers from the probate court and is regulated in the management and investment activities by the court?

Answer 21

False
A trustee receives his or her powers from the trust instrument and is not regulated by the court unless it is a testamentary trust created under a will. Of course, if the instrument is ambiguous or silent with regard to certain powers, the laws of the jurisdiction in which the trust is located will be looked to for guidance.

Question 22

The Uniform Prudent Investor Act of 1994 strictly prohibits the delegation of investment powers by a fiduciary?

Answer 22

False
Under the Uniform Prudent Investor Act, fiduciaries are encouraged to delegate to professionals when necessary or when the particular arrangement would be improved.

Question 23

A general power of appointment allows the donee to transfer the property to anyone, including the donee and the creditors of the donee?

Answer 23

True

Question 24

State law generally limits how long an irrevocable living trust can remain operating?

Answer 24

True

Question 25

A revocable trust is not permitted to hold an unincorporated business interest?

Answer 25

A revocable trust may hold a sole proprietorship or partnership interest. This is a business continuation technique that may be used to prevent the termination of an unincorporated business by operation of law at the death of an owner

Question 26

An irrevocable trust is often used for tax planning purposes as an income-shifting device?

Answer 26

True

Question 27

When the grantor establishes a trust, it is always for the benefit of other persons for whose welfare the grantor may be responsible?

Answer 27

False
The grantor or settlor of a trust may establish a trust for the benefit of any individual, including himself or herself or a charitable organization. The grantor may name certain individuals as income beneficiaries and other individuals as remainderpersons or second-generation beneficiaries.

Question 28

The rule against perpetuities has been abolished in most states, and modern trusts may be established for unlimited duration?

Answer 28

False
The rule against perpetuities is valid in most states today and prevents the creation of a trust that does not vest property within the period of some life that is in existence at the creation of the trust plus 21 years.

Question 29

A donor may delay the right to exercise a power of appointment until the donee’s death?

Answer 29

True

Question 30

In choosing the right executor, the general rule of thumb is to select a close family member who knows the testator well?

Answer 30

False
Although a close family member may be the individual who best knows the testator’s wishes, there are other important factors a person should consider when nominating an executor. These factors could include whether or not the potential executor (1) has the financial and administrative acumen to be an executor (2) has sufficient time to carry out the duties of an executor (3) has sufficient knowledge of the testator’s business, family, and personal matters (4) is likely to be compatible with estate beneficiaries

Question 31

The terms of charitable trusts should not provide a benefit for a specific individual?

Answer 31

True

Question 32

The individual who creates a power of appointment in another (that is, the donor of the power) is the person who exercises the power in favor of the donee at some time in the future?

Answer 32

False
The donee of the power of appointment is the person who exercises the power in favor of the donor at some time in the future.