The Difference Between Directed Trusts vs Delegated Trusts

In the world of trust administration, there is much discussion about what method provides a better bifurcation of traditional fiduciary duties, directed trust models or delegated trust models. At its core, it is a question of how much authority do you want to shift from the trustee to the advisor, how involved you want the trustee to be, and how much responsibility for the review of the advisor’s actions do you want the trustee to retain. The key to understanding the difference between a delegated trust and a directed trust is to understand the difference between the two terms generally.

Direction

Direction is defined as telling another what to do and how to do it, allowing no freedom as to how the task is performed by the directed party. In the trust realm, the individual who directs the trustee is often referred to as an adviser. A directed trustee has no duty to monitor the actions of the adviser, or to advise or warn the beneficiaries when an adviser’s actions are contrary to what the trustee would do itself. For this reason, it is important that the parties recognize that any actions taken by the directed trustee to review documents or transactions are being performed not to review the direction it has been given, but are simply administrative actions taken solely to allow the fiduciary to perform the actions it has been directed to undertake. 

Delegation

Delegation involves the appointment of an agent to assist in the performance of a specific function. In the trust realm, it involves the appointment of an agent by the trustee to perform a specific aspect of the trustee’s typical duties, such as investment management. When the trustee appoints an agent to assist in the performance of such functions, the standard of care applicable if the fiduciary where personally performing the function continues to apply with respect to (1) selecting and hiring the agent, (2) paying the agent, (3) establishing the scope and terms of the agency relationship, and (4) overseeing the agent’s actions. Delegation therefore involves giving authority to another individual to carry out a specific activity or set of activities, while remaining responsible for the overall performance of the task.

Benefits of Directed Trusts

Flexibility

There can be multiple advisers directing the trustee, addressing specific areas of concern. The most common are the Investment Adviser, the Distribution Adviser, the Trust Protector, and the Special Holdings Adviser. Each brings to the trust a particular set of experience and expertise. For instance, an Investment Adviser can be used to direct the trustee with regard to all investment decisions and a Distribution Adviser can be used to direct the trustee with regard to discretionary exercises of its power to distribute trust property to beneficiaries. 

The lesser known trust advisers are the Trust Protector and the Special Holdings Adviser. The Trust Protector is typically put in place to direct the trustee with regard to more administrative type actions such as a change of trust situs, amendment of the trust document, and the removal and replacement of other fiduciaries. The Special Holdings Adviser is typically used to direct the trustee with regard to a particular asset, typically a closely held entity or an operating business. Under the Uniform Directed Trust Act, all of these advisers are typically referred to collectively as “trust directors;” however, in other statutes they typically are referred to by their individual titles.

Specialization of Expertise

The directed trust’s bifurcation of fiduciary duties allows the various advisers and trustees to focus on their specific areas of expertise when administering the trust. For instance, a professional financial adviser can be responsible for investments, while a close family member serving as distribution adviser can direct the trustee regarding the specific needs of the family relative to distribution of the trust assets. An attorney or other professional adviser can be responsible for directing estate and tax planning matters such as granting the exercise of special powers of appointment, trust governing law and situs changes, as well as trust instrument amendment. In short, the trust structure can function in a way that allows all to focus and provide guidance in their key areas of expertise while providing a cohesive trust administration.

One area where this division of responsibility can be most useful is in the area of closely held entities, or special holdings. These assets often require active oversight of an operating business, valuation of the business interest, and overall risk management related to the business. The directed trust structure can allow for the separation of this responsibility from the trustee to an adviser more familiar with the special holding, its regular activity, and risk mitigation. The adviser can direct the trustee with regard to the trust’s ownership responsibilities as well, such as the election of a board of directors or manager. In this way the adviser can provide information and direction to the trustee on a periodic basis to allow for the proper documentation of assets in the books and records of the trust, allowing the trustee to provide appropriate reporting to the beneficiaries and third parties such as the IRS.

Knowledge of Family Dynamics

The specific reasons that a family may choose to include an adviser are as varied as the powers that they can possess. The most basic reason is family control, it is often more comfortable for a settlor to retain certain control within the family or with individuals closest to the family who are familiar with the family’s value system and dynamic. 

This is most easily illustrated in the case of a distribution trust director, whose intimate knowledge of the family can be crucial to giving maximum effect to the settlor’s intent. That individual will best know who is prudent with their spending and who is frivolous, who has substance abuse issues and when they are well as opposed to under the influence, and any unique dynamics within the family that should be considered when making a distribution from the trust. This type of information may not be easily maintained for a corporate trustee who is not part of the family’s daily life. Providing on-going insight and direction can improve the trust’s administration.

Accountability

While the roles of the trustee and advisers are separated, the structure does allow for a system of checks and balances as each party acts within their specific authority, interacting with the other fiduciaries of the trust for the benefit of the trust beneficiaries. By allowing multiple advisers and trustees, the directed trust structure does allow additional review and interaction throughout its administration. The inclusion of a corporate trustee allows for the much-needed centralization of information and formal record-keeping, as well as the oversight of state and federal level regulators. 

Reduced Fees

One benefit of the directed trust model that is often overlooked is the flexibility in trustee fees that it can allow. There is often a reduction in annual trustee fees due to the directed trustee having been relieved of certain responsibilities. By separating the administerial duties from investment functions and distribution functions, it is also typically easier to remove and replace advisers and other fiduciaries because it doesn’t require a change in trustee. This means that the trust will continue to be administered in the chosen state without interruption. 

A Note About Excluded Trustees

In excluded trustee situations, the adviser providing direction to the trustee is also a trustee. As a trustee, that individual is a co-fiduciary owning all fiduciaries duties and held to the same fiduciary standard as the directed trustee. As such, the directed trustee is often completely removed from the bifurcated duties and the responsible trustee acts alone. For this reason, it is more common in these situations to see a provision that the directed trustee has no liability for acting at the direction of the adviser. 

While this trust structure is also considered a directed trust, it does have some unique challenges which occur where the directed trustee is not included in certain trust activities. The lack of participation can result in a lack of knowledge of day-to-day activity. It is especially important in these situations that the directed or excluded trustee be given all information regarding activities that have occurred within the trust so that it can properly maintain the trust records and accountings. Communication in these situations is essential.

The Challenges of Delegated Trusts

Many older trusts pre-date the directed trust model. As such, they do not contain the clear bifurcation of duties and responsibilities that are common in modern trusts. In these situations, trustees may choose to utilize the delegated trust model, relying on the trustee’s power to hire agents common in most trust instruments. Agents can be engaged to do things like manage investments, prepare accountings, or prepare trust tax returns. While this does allow flexibility in administration, it does not provide the complete bifurcation of responsibility which is so important to the success of a directed trust.

Lack of Clarity Regarding Responsibility

A well written directed trust document clearly bifurcates decision making between the trustee and adviser. In so doing, the document eliminates the trustee from all decision-making authority over the directed action as well as from naming or participating in the appointment of the adviser. 

In delegated trusts, the role of the trustee is outlined in the trust instrument; however, the role of the advisers and other agents are found in the various letters of engagement. The liability standard, terms of engagement, and fees associated with the adviser’s role are all defined by the adviser’s engagement letter which may not align with the specific responsibilities that the trustee is intending to bifurcate. There may also be parts of the bifurcated role that remain with the trustee due to the omission of the same in the separate engagement letter.

In addition, the trustee who delegates responsibility to an agent, is not fully removed from the activity. The trustee retains an on-going duty to monitor, warn or otherwise intervene with regard to the actions of the adviser, at times substituting its own judgment for that of the adviser. The trustee also retains the same level of liability for the actions of the adviser established for its own actions within the trust instrument, regardless of the liability level included in the adviser’s engagement letter.

Conclusion

While both directed and delegated trusts provide viable options for the use of specialized advisers, the directed trust option is typically preferred by trustees. It provides the clearest bifurcation of responsibility, found in the trust document, allowing all parties the freedom and flexibility to exercise their authority within defined parameters.   

Commonwealth Trust Company is pleased to provide this article as a guide. Commonwealth Trust Company is not engaged in the practice of law and is not providing legal advice by the provision of these materials. Commonwealth Trust Company recommends that clients seek the opinion of their attorney regarding the specific legal and tax issues addressed in this article.