The differences between a directed trust and a delegated trust primarily comes down to who has the responsibility for the execution of trustee duties, most commonly, investment and distribution duties. This difference is a direct result of how the trust was drafted, and whether or not the trust was drafted to accommodate the separation of power and responsibility for different trustee duties.
The primary distinction that differentiates whether a trust is delegated or directed comes down to who has the power under the terms of the trust document for either distribution or investment actions.
The Main Difference: Power = Responsibility
Whoever has the power under the terms of the trust, also has the responsibility to exercise that power as a fiduciary. A trustee who has the power to make investment decisions for a trust, is not only responsible for all his or her actions, but also for the actions of any other individual to whom the trustee delegates that responsibility.
For example, a trustee may wish to have the trust assets professionally managed by a financial advisor. If the trust document does not allow for the separation of trustee powers, the trustee is still responsible for everything that financial advisor does with those trust assets. This is an example of a delegated trust, where the trustee has delegated the responsibility to invest trust assets to the financial advisor, however the trustee has not handed off any of their responsibility as trustee for the proper investment of the trust assets. Because a trustee is still acting in a fiduciary capacity as it pertains to investments with a delegated trust, there is a heightened level of liability for the trustee. In a delegated relationship, the trustee has handed over control and oversight of investments to a financial advisor, but remains responsible for all their actions or inactions as to the investment of those trust assets.
Delegated trusts are often “old and cold” trust documents that were not drafted with the foresight that someone other than the trustee would need to be able to manage the trust assets. Directed trusts solve for many of the issues that come with delegation for both the trustee, the financial advisor and the beneficiaries. A directed trust provides for the separation of investment and/or distribution powers and all other trustee duties. The trustee of a directed trust who does not have investment powers is not responsible for the actions or inaction of the party named in the trust to direct investment actions.
What is a Directed Trust?
A directed trust allows someone designated by the grantor in the trust document to direct the trustee to make certain decisions, such as investments and distributions. The trustee of a directed trust is not responsible for the decisions, actions, or inaction of the party having authority to direct the trustee. Because of this, the trustee of a directed trust faces less exposure and liability because it must follow the direction of whomever the trust document appoints to direct the trustee’s actions.
What is a Delegated Trust?
With a delegated trust, the trustee is responsible for appointing an investment advisor to manage the investment of trust assets. Delegated trusts are often existing trusts that were not drafted with indemnification and bifurcation language to allow for the flexibility to separate trustee duties. Because duties cannot be separated, the trustee is responsible for performing due diligence on the advisor, overseeing the chosen investments, monitoring the advisor’s investment performance, and managing distributions according to the terms of the trust document.
With a delegated trust, the trustee has more authority but also more exposure and liability than with a directed trust, because the trustee is still responsible for fulfilling its fiduciary duty in the selection and oversight of third parties to whom investment and other duties are delegated.
Investments
With a directed trust, the terms of the trust typically will designate an investment advisor who will direct the trustee regarding all investment-related actions taken on the account. The trustee will not take action without direction from the appropriate party authorized by the terms of the trust.
With a delegated trust, the trustee delegates the management of trust assets to an investment advisor. Such delegation is a fiduciary duty undertaken by the trustee and thus it must proactively monitor the advisor’s performance according to the requirements of the trust and relative to industry standards.
Distributions
If a trust is “directed” for distributions, the trustee will follow the direction of the party authorized in the trust document to make distribution decisions. The trustee is not responsible for determining the appropriateness of any distribution decision made by such party.
With a delegated trust, the trustee will make distribution decisions consistent with the terms of the trust document, the grantor’s intent, and the best interest of the beneficiaries. Some trustees may also delegate distribution authority in addition to investment duties, while some trustees will not.
Why Choose One Over the Other?
When there is a choice of delegated over directed, it is almost always more advantageous for all concerned to structure a trust as directed versus delegated, but unfortunately, there is not always the option to do so in every situation. While trusts are in the drafting stage, any flexibility for the separation of trustee powers that the grantor desires can be drafted into the trust document. However, once an irrevocable trust is drafted, it can be laborious and expensive to make the necessary changes to allow for a directed structure, versus a delegated relationship.
On the other hand, because of the heightened level of liability and monitoring required with a delegated trust, trustees who accept delegated trusts often charge higher fees for these relationships. If a directed structure can be achieved by decanting or other workarounds, it may be the less expensive and more desirable structure long term. However, going through the effort of decanting or amending a trust document may not be possible or reasonable for all existing trust documents and situations. Understanding whether or not it is feasible to obtain a directed structure with a trust that does not permit the separation of trustee duties will require the advice of skilled legal counsel.
If you have more questions about directed or delegated trusts, get in touch with a trust officer at Peak Trust Company today!