What is a Directed Trust?
In its simplest form, a directed trust is a trust arrangement that effectively relieves the trustee of specific duties, such as investments or distributions, and requires the trustee to act upon the direction of an advisor named in the trust agreement. Directed trusts are often directed as to investments and/or directed as to distributions. For example, with a directed trust that is directed for investments, the trust's terms specify an appointed investment advisor who holds the authority to direct the trustee in all matters related to investments within the trust. The trustee, in this scenario, takes direction for all investment-related actions guided by explicit guidance from the authorized party designated by the trust's terms. This division of responsibilities results in a partnership where the trust company or trustee manages the administrative aspects of the trust, while the client's chosen financial advisor or family advisor maintains control over investment decisions and asset management.
The Rise of Directed Trusts: A Win-Win for Advisors and Clients
The transformation of many trust companies into comprehensive wealth management firms has presented a predicament for financial advisors serving high-net-worth clients. They often find themselves in the awkward position of surrendering control over a portion or the entirety of their clients' assets to a competing entity when recommending the creation of a trust.
Directed trusts offer a solution, allowing the grantor to instruct the trust company to follow the investment directives of an external advisor. In such arrangements, the control over assets, along with the associated investment fees, remains with the advisor, while the trustee assumes the responsibility for trust administration.
In essence, directed trusts align the interests of all parties involved, including grantors and beneficiaries, while minimizing potential conflicts. It's important to note that in directed trusts, someone other than the trustee is responsible for managing the underlying assets. This marks a departure from traditional common law trusts, where the trustee holds responsibility for both property administration and investment decisions.
With a directed trust, control over the assets (and the investment fees they generate) remains with the advisor, while the trustee administers the trust itself.
Directed trusts, as a practice, originated with the Uniform Prudent Investor Act of 1994. Early beneficiaries of these arrangements utilized them to consolidate control over family-held business entities. Since these families possessed a profound understanding of their business operations, directed trusts allowed them to create family LLPs or LLCs and transfer ownership units into the trust. A trust company would act as trustee, while the partnership manager retained control over the enterprise, resulting in a beneficial outcome for all parties involved.
Over the past few decades, the concept of directed trusts has expanded to include more conventional asset classes such as stocks, bonds, cash, and other marketable securities. As before, the legacy advisor, who is most familiar with managing the wealth, continues to oversee investments, while a trust company serves as the trustee, leading to a mutually advantageous setup.
The Directed Trust Company
In the last two decades, a dynamic industry of independent trust companies, such as Peak Trust Company, has emerged as specialized directed trust providers. The best-directed trust companies support open architecture custody platforms, enabling them to manage trust clients' portfolios across a broad range of asset classes, including cash, stocks, individual bonds, mutual funds, exchange-traded funds, and exotic instruments—all in line with the client's directives.
Typically, fees for administration and custody at directed trust companies are approximately half of what comprehensive firms charge for bundled wealth management and trust administration services. Fees in the financial sector can vary significantly, so advisors should explore options on behalf of their clients.
Additionally, the investment manager directing the trust assets retains the authority to set their own management fees and, when appropriate, performance fees. Directed trust companies are often able to avoid additional charges that full-service trust companies may impose for handling complex or illiquid assets since they assume the responsibility and liability for managing such assets.
In conclusion, directed trusts have emerged as a beneficial solution for high-net-worth clients, financial advisors, and trust companies. By separating administrative and investment responsibilities, these trusts create a harmonious environment where all parties can focus on what they do best while ensuring the best interests of the grantors and beneficiaries are upheld. The growth of directed trust companies has further expanded the reach and versatility of this financial strategy, offering more options and cost-effective solutions for clients seeking tailored trust management.
If you have more questions about directed trusts, get in touch with a trust officer at Peak Trust Company today!