What is a Directed Trust
Most people who work with personal trusts are aware of directed trusts — but not all are familiar with the benefits that they provide to settlors. Directed trusts have become increasingly popular over the past decade or so. That growing popularity is largely due to the level of flexibility these trusts offer. At Commonwealth Trust, we only administer directed trusts, and leave the investing to our clients and their advisors. This differs from other types of trusts, which require you to use a financial advisor that’s associated with the trust company, giving you far less control over your investments.
In this article, we’ll explore what a directed trust is, how it works, and the benefits it offers.
What is a directed trust?
A directed trust is a type of trust where responsibilities are split amongst multiple parties — the directed trustee and the trust advisor. The directed trustee’s role is limited to the administrative duties. This means that the directed trustee is not responsible for making investment decisions, distributing assets to beneficiaries, or managing the trust’s investment portfolio. The specific division of responsibilities can vary, sometimes having advisors take responsibility for investment decisions, but leaving the trustee with distribution discretion. In other instances, both the investment and distribution responsibilities reside with advisors and the directed trustee performs the more administrative functions of the trustee.
In the case of Commonwealth, the trust’s investments are instead directed by a separate party who is appointed to make these decisions. They are known as the Trust Advisor, and they are responsible for managing the trust assets and making all investment decisions, following the trust’s terms and goals.
How does a directed trust work?
The responsibilities of the directed trustee are generally limited to administrative duties such as record-keeping, accounting, and tax filings. The trustee’s role is not to make investment decisions (and in some instances not to make distribution decisions with regard to the needs of beneficiaries), but rather to follow the written directions of the Trust Advisors who are responsible for managing the trust assets or making distribution decisions.
The Trust Advisor who is responsible for investment decisions is typically known as the “Investment Advisor” and is appointed by the creator of the trust. They are typically the creator of the trust themselves, an investment professional, attorney, financial advisor, or a trusted friend. Both the directed trustee and the Trust Advisor are required by law to follow the terms of the trust and act in the best interests of the beneficiaries.
Delaware directed trusts
One of the most important considerations when creating a directed trust is the jurisdiction in which it is established. While many states allow for directed trusts, some are considered more favorable than others. One state that has emerged as a leader in directed trusts is Delaware.
Delaware is widely considered to be one of the best jurisdictions for directed trusts due to its favorable trust laws and business-friendly environment. The state has a long history of trust expertise and offers a well-developed legal framework for trusts, tax advantages, and a high degree of flexibility for trust management.
Additionally, the unique setup of the Delaware Court of Chancery provides additional benefits for those with trusts based in Delaware. The Court of Chancery is a court of equity, rather than a court of law. Essentially this means that the court makes decisions based on what is fair and equal, while a court of law must follow what is written in the law. The Court focuses exclusively on fiduciary and commercial matters, resulting in a less-backlogged, more streamlined court, and judges who focus exclusively on business and trust matters.
The benefits of a directed trust
There are many beneficial features of directed trusts, notably the control and flexibility over trust administration.
Flexibility & Control
A directed trust provides greater flexibility and control for the settlor, or creator of the trust, to customize the trust to meet their specific needs and goals. The grantor can appoint trust advisors who have the expertise and experience to manage the trust’s assets, and the trust can be tailored to meet the unique needs of the beneficiaries. The ability to have full control over who is managing the investments, like a trusted advisor who has worked with the family for years, is one of the main benefits of directed trusts.
One of the most valued features of a directed trust is the flexibility with wealth planning strategies. In many trusts, the party responsible for managing investments has a fiduciary duty to diversify the investments. However, for individuals with wealth concentrated in one main area, like the owners of a family business, or those with the majority of their investments in a specific sector like real estate, that lack of flexibility over investments can be a hindrance.
Directed trusts offer far greater flexibility in the makeup of the trust’s investments — Delaware’s Prudent Investor Rule means that the investment performance is judged based on the performance of the entire portfolio, as opposed to on an asset by asset basis. The duty of diversification is waived, offering far more flexibility over the assets that make up the portfolio.
Another benefit of how directed trusts are laid out is that not only can the settlor choose whoever they want to manage their investments, the settlor can also manage their own investments directly, giving up zero control over their investment strategy.
Because the Trust Advisor is typically an investment professional or other trusted advisor, they bring a high level of expertise and experience to the management of the trust assets. This can result in better investment performance and more effective management of the trust.
This is also beneficial when considering the role of the directed trustee, who is responsible for the trust administration. These parties, like our team at Commonwealth, work on trust administration as a full-time job, knowing every in-and-out of the industry, and leveraging their expertise to the client’s benefit. With the expertise that directed trustees bring, clients can feel confident that their trusts are set up in the most beneficial manner, no matter what their goals are.
A directed trust provides a system of checks and balances, with the trustee responsible for administrative tasks and the Trust Advisors responsible for investment and distribution decisions. This helps to ensure that the trust is managed in the best interests of the beneficiaries, and that the trustees and Trust Advisors are accountable for their actions. In addition, Delaware directed trustees are overseen by the Office of the State Bank Commissioner ensuring that they are compliant with industry standards in trust administration.
A directed trust is a flexible and powerful tool for managing trust administration and providing for the needs of beneficiaries. Full control over who the Trust Advisor is means that the person with the most knowledge of the values and day-to-day needs of the settlor and beneficiaries is the decision maker — providing valuable peace of mind to the settlor and their family. With the control, expertise, and flexibility that a directed trust provides, it is no wonder that it is becoming an increasingly popular choice for estate planning.
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.