Trustee Discretion – Whether to Consider ‘Other Financial Resources’

Take-Away: Many individuals are now establishing fully discretionary trusts for their children and grandchildren. The motivation behind these trusts are to shield the trust assets from the trust beneficiary’s creditors, and also to exclude the trust’s assets from being exposed to federal estate taxation on the trust beneficiary’s death. Often unaddressed in these discretionary trusts is whether the beneficiary’s own financial resources need to be considered when the trustee makes a discretionary distribution. The common law, as summarized below, provides competing interpretations of the need to consider the trust beneficiary’s other or ‘outside’ financial resources in making a discretionary distribution.

Background: The question of whether a trustee must take into consideration a trust beneficiary’s other financial resources in making a discretionary distribution from a trust is often the subject of probate litigation. If the trust instrument is silent on this question of looking to other assets first before making a discretionary distribution using trust assets, a fair assumption is that the trust settlor did not consider the question. If the trust instrument is silent on whether the trust beneficiary’s other financial resources must be considered, the trustee must then determine what the settlor intended had the drafting attorney expressly presented the settlor with this question.

Michigan Statutes: The Michigan Trust Code has a few statutes that directly deal with discretionary trusts, but none of them address the issue of whether the trustee must consider the beneficiary’s other financial resources, should be considered, should not be considered, and if considered, what the term ‘resources’ actually means.

MCL 700.7103(d): A discretionary trust provision is defined to mean a provision in a trust, regardless of whether the terms of the trust provide a standard for the exercise of the trustee’s discretion and regardless of whether the trust contains a spendthrift provision, that provides that the trustee has discretion, or words of similar import, to make distributions. There is no mention of the trustee taking the beneficiary’s own resources into consideration in the exercise of such discretion. No specific language is required in order to create a discretionary trust provision.
MCL 700.7505: This section provides that the creditor of a beneficiary of a discretionary trust provision does not have any right to any amount of trust income or principal that may be distributed only in the exercise of the trustee’s discretion. This codifies Michigan’s common law that a creditor has no greater right to trust property than does the trust beneficiary, and the beneficiary of a discretionary trust has no right to receive trust property.
MCL 700.7815: This section reiterates that a beneficiary of a discretionary trust has no property right or property interest in a trust. Again, there is no mention of what the trustee must consider in the exercise of its discretion under a discretionary trust provision.

Common Law: A general rule of construction under the common law is that the trustee must consider the beneficiary’s other resources, but the trustee does have some latitude in the exercise of this discretion. This is one of the areas where the common law, as summarized in the three Restatements of Trust, differ from one another.

Restatement (Third) of Trusts (2003): Section 50(2) of this Restatement deals with the issue of whether the trustee may, or must, take other resources available to the trust beneficiary into account when making a discretionary distribution from the trust. Comment (e) to this Section creates a presumption, subject to a couple of qualifications, that the trustee should take these ‘other resources’ into account to determine whether, and in what amounts, a distribution is to be made to the beneficiary. That Comment also notes that this presumption should not apply when the settlor expresses a contrary intent, or where applying such a presumption would be contrary to the trust’s material purposes or the express terms of the trust instrument. The Comments to Section 50(2) provide that no matter how broad the trustee’s discretionary standard is- even if happiness is included- the trustee’s consideration of other resources is still a factor in the determination of whether the trustee’s exercise of discretion was reasonable. Equally important, the Reporter’s Note to Section 50(2) acknowledges that this presumption is a departure from the prior two Restatements of Trusts.
The qualifications described in Section 50 are: (i) First, if there are other resources that the trustee readily knows about, such as a mandatory distribution of income from the same trust, or payment from another trust that is part of a coordinated estate plan, such resources should be taken into consideration in making a discretionary distribution; (ii) Second, if the settlor or decedent identified a period of time during which the beneficiary was not expected to be self-supporting, then the inference is that the trustee should not deny discretionary distributions; (iii) Third, the trustee’s consideration of other resources may have a bearing on the overall reasonableness of the trustee’s exercise of discretion, even when there are nonobjective distribution standards such as ‘benefit’ and ‘happiness;’ and (iv) Fourth, the grant of extended discretion to the trustee, as indicated by the use of words like ‘sole’ and/or ‘absolute discretion’ does not necessarily imply one way or the other, but may suggest that the trustee has greater latitude in the exercise of its discretion.
Restatement (Second) of Trusts (1959): Section 128 of this earlier Restatement of Trusts, presumably summarizing the common law on trust interpretation and administration, infers that the trustee need not take ‘other financial resources’ into consideration unless directed to do so by the terms of the trust instrument. [See Comment (e).] “It is a question of interpretation whether the beneficiary is entitled to support out of the trust fund even though he has other resources. The inference is that he is so entitled.” As such, this Restatement (Second) provides a more liberal distribution standard from the trust beneficiary’s perspective.

Lingering Questions: Inasmuch as neither of the Restatements of Trust, nor the Michigan Trust Code, provide any reference to what constitutes ‘other resources,’ a discretionary trust should provide some direction to the trustee as to what, if anything, needs to be considered. If the trustee may (or must) consider the trust beneficiary’s ‘other resources’, the trustee has to then determine which resources will influence the trustee’s exercise of discretion in making a distribution. Normally a beneficiary’s ‘other resources’ includes the beneficiary’s income and other periodic receipts, such as pensions and annuity distributions. Also included in ‘other resources’ would normally be court-ordered payments like a spousal support award. With the Restatement (Third) of Trusts requiring that ‘other resources’ be considered by the trustee, that leads to other challenging questions such as:

Must the trust beneficiary liquidate other assets prior to receiving a discretionary distribution? [The Restatement (Third) of Trusts states that there may be instances where the beneficiary’s non-income assets should be taken into account, depending on: (I) the liquidity of the assets; (ii) the terms and purposes of the trustee’s discretionary power; (iii) other purposes of the trust, such as its tax purposes; and (iv) the settlor’s relationships and objectives under the trust with regard to all trust beneficiaries.]
Must the trust beneficiary exhaust all of his/her assets prior to receiving a discretionary distribution from the trust?
Must the trust beneficiary demonstrate that he/she was unable to obtain a loan, e.g. a home equity line of credit, as a precondition to receiving a trust distribution?
Is an unemployed or underemployed trust beneficiary unable, or unwilling, to work, so that it is reasonable to impute income to that beneficiary?
If the trust beneficiary is married, does the trust beneficiary’s spouse have financial resources that are indirectly available to the trust beneficiary?
Does the settlor identify in the trust a period of time during which the trust beneficiary was not expected to be self-supporting, e.g. while attending college, which permits an inference that the trustee should not deny discretionary distributions during that period of time.

Conclusion: The two most recent Restatements of Trusts, which purportedly summarize the common law, are inconsistent when it comes to whether the trustee of a discretionary trust must take into consideration a trust beneficiary’s ‘other resources’ prior to making a discretionary distribution. One has to wonder if a long-standing trust created prior to 2003, when the Restatement (Second) of Trusts prevailed should be interpreted as if the trustee need not consider the trust beneficiary’s ‘other resources’, while a trust that is created after 2003 must consider the beneficiary’s ‘other resources’ as suggested by the Restatement (Third) of Trusts. Nor does the Michigan Trust Code help to provide much guidance on this question. In order to minimize the trustee confusion in carrying out a discretionary trust, like a dynasty-type of irrevocable trust, the trust instrument should include language not only with regard to whether ‘other resources’ need to be considered by the trustee in making a discretionary distribution, but if they are to be considered, the trust instrument needs to define what ‘other resources’ includes, as well as address some of the subjective questions like the under-employed trust beneficiary, or the trust beneficiary’s ability to pledge ‘other resource’ assets to obtain a loan to meet their financial needs.