A Will has been probated by the Courts creating a discretionary, testamentary trust for a beneficiary. If you are appointed as trustee of that trust, what are your duties and what is required to set up and manage a trust for the benefit of the beneficiary?

What follows is a concise summary of what’s required of a trustee.

Duty to Keep Records

Since you will eventually have to account to the beneficiary for your management of the trust, you must keep very careful records of the transactions. You should keep a book of the account showing all receipts and disbursements and all investments made from time to time. Each entry should show the date, description of the transaction and the exact amount of the receipt or payment.

We recommend that you also keep a diary of your administration of the trust in which you record the date, decision made and the reason for the decision. This will be useful should you ever be required to pass your accounts in the Court and explain why you made a particular decision.

Investments must be registered in your name in your capacity as trustees of the trust for the beneficiary.

Duty to Account

You must account to the beneficiary for your administration of the trust on a regular basis. If the beneficiary is not satisfied with your accounting, he or she can apply to the Court for an order requiring you to pass your accounts. This is rarely done, but you must remember your duty to account.

Maintenance, Education, and Benefit

The trust gives you the power to pay the income and capital for the “maintenance, education, benefit or other benefit” of the the beneficiary. Generally these words have the following meanings:

“Maintenance” includes the basic necessities of life including food, clothing, shelter, etc.
“Education” generally includes tuition, books, supplies, etc.
“Benefit” is a broad term generally used to enlarge the number of things which a trustee can do to improve a beneficiary’s situation.

Taken together, these terms both in the will and the Trustee Act, give you sufficient authority to use the income and capital of the trust to take care of most of the beneficiary’s needs. If you have any doubt as to whether a particular expenditure on behalf of the beneficiary is allowed by this authority, you should discuss this with us.

Duty to Invest

As trustee, you have a legal duty to invest the assets. Depending upon the terms of this will, this duty includes the duty to earn income and also to provide for growth in the value of the capital of the assets.

Investing in a guaranteed investment certificate with a bank might provide a good source of income, but there would be no growth in capital. Over time, inflation will erode the benefit to the beneficiary and the trust. When the capital is eventually transferred to the beneficiary, he may complain that the capital has lost its significance in terms of the power to earn income. A well rounded investment strategy should therefore be established.

Prudent Investor Rule

The Trustee Act of adopted the prudent investor rule, which can be summarized as follows:

subject to the terms of the trust, trustees should invest trust property with a view to obtaining a reasonable return while avoiding undue risk, having regard to the circumstances of the trust.
trustees should evaluate the expected return and risk associated with the investment strategies or decisions within the context of the overall trust portfolio, rather than by focusing on particular investments in isolation.
trustees should review the trust portfolio at reasonable intervals for the purpose of confirming that the portfolio continues to be appropriate to the circumstances of the trust.

Modern portfolio theory states that investment risk may be managed through the use of a properly diversified portfolio, such as would be maintained by a reasonably prudent investor. The goal of the prudent investor is not simply to minimize risk to the investments held on behalf of the trust, but to choose a portfolio that achieves an optimal relationship between expected return and risk. Risk is judged on a portfolio as a whole, rather than on an asset‑by‑asset basis. The idea can be summed up by the old adage “don’t put all your eggs in one basket.” The following is a somewhat whimsical discussion of modern portfolio theory from a report of the Alberta Law Reform Institute:

Certainly, if you decide to invest in eggs, make sure they are not all in the same basket. But that is not an adequate diversification strategy. Even if you were concerned only with the risk of physical destruction of your eggs, putting them in different baskets would not really protect you from losing your total investment in eggs to one catastrophe. What if all your eggs, albeit in different baskets, are in the same semi‑trailer whose refrigeration unit malfunctions in the middle of nowhere in a hot summer day? Insofar a physical risks to your investment in eggs is concerned, an effective diversification strategy must ensure that there is a negligible risk that one single calamity will wipe out all or a substantial proportion of your holding of eggs.

Suppose that you have developed and applied a strategy for investing in eggs that ensures that no single calamity will destroy more than 5% of your eggs. You have invested all of the money that you have available for investment in eggs. The obvious problem with your diversification strategy is that it only addresses one sort of risk: physical destruction of your eggs. Your strategy does nothing to protect you from a dramatic decline in the price of eggs that might be brought about by a change in consumer tastes, a dramatic increase in the supply of eggs, or other market forces. Your total investment portfolio is subject to the risk of a decline in egg prices. To protect yourself against this sort of risk, you must diversify by spreading your investment dollars amongst assets whose prices are not highly correlated.

The British Columbia Law Institute described modern portfolio theory in this way:

These rules (the old legal list approach) tend to discourage trustees from applying investment strategies that make use of modern portfolio theory, which is based on reduction of overall risk to the portfolio as a whole by acquiring a wide range of investments. Those carrying higher return, and correspondingly greater risk, are balanced in a well‑diversified fund by those carrying lower risk. Portfolio theory recognizes the fact that concentration in a few securities means losses in those categories will magnify the proportional loss to a fund. It also recognizes that the probability of loss in a great number of categories at the same time is much smaller than the chance of loss in one category. In other words, modern portfolio theory favours diversification.

The Alberta Law Reform Institute summarized the following features of modern portfolio theory:

The goal of the prudent investor (or the trustee employing the prudent investor rule), is not simply to minimize risk; it is to optimize the risk‑expected return relationship. Having determined a target rate of return, the objective is to select a portfolio with the highest expected return. Conversely, having a determined level of risk, the objective is to select a portfolio with the highest expected return consistent with the accepted level of risk.
Risk is judged on a portfolio‑wide basis, rather than an asset‑by‑asset basis. Investing a portion of the trust funds in highly volatile assets could be part of a prudent investment strategy. Indeed, adding a volatile (risky) asset to a portfolio might actually decrease the overall volatility (riskiness) of the portfolio, depending on the degree and direction (positive or negative) of correlation between the asset and the rest of the portfolio.
The key to effective risk management is diversification, and the key to effective diversification is selecting assets whose expected returns are negatively correlated, uncorrelated, or at least only weakly correlated with each other.

Power to Delegate

The prudent investor rule allows you to delegate investment decisions, but you may not totally abrogate your duties. If you delegate your investment authority, you must exercise prudence in:

Selecting the advisor;
Establishing the terms of the authority delegated; and
Monitoring the performance of the advisor to ensure compliance with the terms of the delegation.

These same rules should be applied whether you have the authority to delegate your powers of investment or whether you are making the investment decisions based upon the advice of your investment advisor. This will require meeting regularly with the investment advisor and carefully considering his or her recommendations.

Liability

You are free to invest your own assets in any way you wish. If you suffer loss, you have only yourself to answer to.

As a trustee, you owe a fiduciary duty to the beneficiary of the trust. If the trust suffers a loss, or fails to achieve a reasonable return, you may be personally liable to the beneficiary of the trust if you have failed to invest prudently.

Will I be Liable if I Make Reasonable Decisions?

A trustee will not be liable for a loss to the trust if the loss arises from a decision or course of action that follows the criteria required of a prudent investor. Section 4 of the Trustee Act reads as follows:

4(1) A trustee is not liable for a loss in connection with the investment of trust funds that arises from a decision or course of action that a trustee exercising reasonable skill and prudence and complying with the section 3 could reasonably have made or adopted.
(2) A court assessing the damages payable by a trustee for a loss to the trust arising from the investments of trust funds may take into account the overall performance of the investments.

This means that you should adopt a plan or strategy for the investment of the trust property. That plan must take into consideration the criteria reviewed later in this letter.

The duty of prudence includes a duty to obtain investment advice in appropriate circumstances. Your investment advisor should put the plan in writing and it should be reviewed on a regular basis. How often should it be reviewed? This depends on the nature of the trust, the needs of the beneficiary and the vagaries of the economy. In a volatile economy, a more regular review of the plan and the investment portfolio should be undertaken.

What Investment Strategy is Right for the Trust?

Each trust and each beneficiary requires a unique plan. An 85 year old widow will have different needs than a five year old orphan. An 18 year old student about to enter university will require a different investment program than for a 60 year old widower. Investment for a 40 year old professional in a high income bracket will require a different approach than for a 25 year old handicapped child. As the beneficiary ages, his or her needs will require adjustments to the investment plan.

The terms of the trust must also be carefully examined. If the trust limits your investments, you are required to invest within those limitations. A trust which requires income only to be paid with no power to encroach on capital will require a different investment strategy than if the capital is to be transferred to the beneficiary at various stages. If more than one class of beneficiary is entitled to the trust over time, an even hand must be maintained between the classes of the beneficiary, unless the trust provides otherwise.

How to improve an Investment Plan

If you fail to invest the assets of the trust prudently, you could ultimately be liable to the beneficiary if there is a loss in the trust or if the beneficiary complains that the return has not been sufficient. In determining which investments you intend to make, you should therefore seek the advice of a competent investment advisor. We suggest you proceed as follows:

Choose a competent investor advisor. If you do not have an advisor who is qualified to advise you in this area, interview a number of advisors. Review their qualifications and the support that their companies can provide. Allow them to review the trust and the needs of the beneficiary. Get them to explain how they will develop an investment plan for the trust. Choose an advisor that you are confident will provide you with competent advice on an ongoing basis.
Develop an investment plan with your investment advisor having regard for the following criteria:

the purpose and probable duration of the trust, the total value of the trust’s assets and the needs and circumstances of the beneficiary;
the duty to act impartially towards beneficiaries and between different classes of beneficiaries;
the special relationship or value of an asset to the purpose of the trust or to one or more of the beneficiaries;
the need to maintain the real value of the capital or income of the trust;
the need to maintain a balance that is appropriate to the circumstances of the trust between:

risk;
expected total return from income and the appreciation of capital;
liquidity; and
regularity of income.

the importance of diversifying the investments to an extent that is appropriate to the circumstances of the trust;
the role of different investments or courses of action in the trust portfolio;
the costs, such as commissions and fees, of investment decisions or strategies;
the expected tax consequences of investment decisions or strategies.

These criteria must be consistent with the terms and relevant to the circumstances of the trust. For example, if there is a likelihood that you will need to disburse funds to the beneficiary at unpredictable times, this could demand a greater emphasis on liquidity within the portfolio than would be warranted if the income demands were more predictable. A well-qualified investment advisor may be able to suggest other criteria that will be relevant to the trust.

Ensure that the plan provides an appropriate diversification of trust property having regard to:

The requirements of the trust; and
General economic and investment market conditions.

Have your advisor outline the investment plan in writing. As the plan changes, have your advisor record the changes to the plan in writing.
Have your advisor provide you with a written investment policy statement and review it regularly with your advisor.
All investment accounts must be registered in your name as trustee. You must keep the assets segregated from any of your personal investments.
Monitor the performance of your advisor on a regular basis. Volatile times require more frequent reviews.
Regularly review your administration of the trust with your lawyers and when in doubt, seek legal advice.

Conclusion

The management of a trust by a trustee involves a great deal of responsibility. This is one reason why trustees are entitled to compensation. Prudent management is the key to meeting your obligations.

Summary of Steps:

Meet with a bank account manager and set up a Trust Account;
Transfer the beneficiary’s share into the Trust Account;
Meet with an investment advisor and decide how the trust assets will be invested and managed;
Meet with an accountant to register the Trust with the CRA and understand your tax and reporting obligations;
Meet with the beneficiary to explain how the Trust will work and work on a budget with him or her so that you know what his or her needs will be going forward.

Best of luck in your journey ahead.

Nicole Garton is president and co-founder of Heritage Trust.

Recognized by Best Lawyers in Canada for trusts and estates and family law, she previously chaired the Canadian Bar Association Wills and Trusts Subsection (Vancouver).

Contact Nicole by email or phone at (778) 742-5005 x216.

Heritage Trust is a leading non-deposit taking financial institution, regulated by the BC Financial Services Authority (BCFSA), a government agency of the Province of British Columbia. Heritage Trust offers caring and professional executor, trustee, power of attorney, committee, escrow and family office services to BC resident clients.

We welcome you to contact us.

The Duties of a Trustee of a Testamentary Discretionary Trust