The "Prudent Investor" Rule:
Keep in mind that the trustee must act in a
fiduciary capacity on behalf of the interests of both
parties to the CRT - the donor/beneficiary and the
remainderman. This means an impartial administration
of trust assets to provide both favorable current
income, and also preservation of the largest possible
remaining corpus for the designated charity.
The Third Restatement of the Law of Trusts,
section 227, the authoritative treatise on such
matters, imposes a duty on a trustee to manage a trust
as a "prudent investor," balancing the rights of the
beneficiary and the remainderman in light of the terms
of the trust declaration, payout requirements and all
other circumstances including inflationary
considerations.
The difficulty arises when market conditions make
it impossible to satisfy both parties' best interests.
Then the trustee is expected to look for direction to
the donor's intent as expressed in the trust
declaration - yet another reason the drafting of that
basic document is of such great importance. The
question then becomes, did the grantor intend to favor
the remainderman over the current income beneficiary?
Under the codified Third Restatement rules, a trustee
would rarely implement an investment policy that
clearly favors one side over the other, unless the
trust declaration unambiguously directed such a course.
This is so because the Restatement suggests that a
trustee can be held personally financially responsible
for investing in a manner that favors the beneficiary
at the expense of the remainderman, especially if the
diminished principal loses purchasing power due to
inflation.
For example, a trust arrangement which allows the
beneficiary to receive payment out of principal when
current income is insufficient, clearly harms the
interest of the remainderman - an inherent conflict of
interest for the trustee. This dilemma can be avoided
so long as the overall rate of return (current income
plus capital appreciation) meets the payout
requirement, and thus keeps the corpus intact. But
when the trustee must figure in inflation, principal
may have to be invaded to pay the beneficiary. As we
have already discussed, setting the payout rate at the
minimum 5 percent will usually avoid this conflict, but
higher payout rates might guarantee the problem.
The practical solution is to set the payout rate
as low as possible (5 percent), so that an experienced
trustee's wisely diversified portfolio of investments
can earn interest and dividends sufficient to meet all
current income needs with inflation taken into account.
Don't forget in this discussion of "competing
interests" between CRT beneficiaries and the
remainderman; the sole policy reason the law allows and
encourages charitable remainder trusts (and the
concomitant benefits to donors), is the ultimate
objective of promoting charitable organizations and the
achievement of their goals by tax-exempt private
financing. The IRS does not look favorably on
operating a sham CRT providing bountiful lifetime
rewards to its donor/beneficiary, while ultimately
short changing the charitable organization it was
created to help. Follow that route and it leads to
enormous retroactive tax liabilities, including
interest and penalties stretching back over the years
to the CRT's date of creation.
In the midst of all these shifting variables, the
"prudent investor" trustee can easily get caught "in
the middle." These problems should suggest how
important it is to choose a qualified CRT trustee who,
in fact, has your complete trust.
