Trusts & Fiduciary Duty
What a trust is
“A trust is a legal entity created to benefit a specific party.”
- People use trusts for many purposes, such as managing family assets, supporting charitable goals, and (in some cases) reducing taxes.
- 🔑 Brokerage accounts opened for trusts are considered fiduciary accounts.
Sidenote: Fiduciaries
“A fiduciary is a third party who oversees someone else’s assets.”
- ⚠️ Fiduciaries must put the client’s interests ahead of their own and act in the client’s best interest.
- With trusts, the trustees (appointed to manage the trust) act in a fiduciary role.
- 🔑 Fiduciary accounts are governed by the Uniform Prudent Investor Act (UPIA), which requires fiduciaries to invest with a holistic (big-picture) perspective.
- Example: if you’re managing an account for a risk-averse investor, the portfolio could still include a few aggressive investments — as long as the overall structure remains conservative.
- ⚠️ A fiduciary’s performance isn’t judged on one or two holdings, but on the overall results of the portfolio they build.
Trust parties
Numerous parties with varying responsibilities are involved with trusts.
| Party | Role | Key facts |
|---|---|---|
| Grantor | Creates and funds the trust | Uses legal services to create a trust agreement, which is the foundation of the trust. Some grantors hire attorneys, others use digital services like LegalZoom. The trust agreement spells out the trust’s objectives, how it will be managed, and who the beneficiaries are. Trusts can serve many goals, such as funding a child’s college education or caring for an elderly parent. |
| Trustee | Manages the trust | Named by the grantor in the trust agreement. Trustees manage the trust as fiduciaries and must follow the grantor’s instructions. When a trust account is opened at a brokerage firm, trustees have the authority to trade and transact in the account. |
| Beneficiary | Receives trust assets | The trust is managed for the sole benefit of its beneficiaries, which may be a person or an organization (for example, a charity). ⚠️ Beneficiaries don’t control the trust because trustees have the decision-making authority. Even so, trustees must serve the trust and its beneficiaries. |
- ⚠️ It’s possible for one person to serve in all three roles — one individual could be the grantor, trustee, and beneficiary at the same time.
Suitability & margin
- ⚠️ Trust accounts are fiduciary accounts, but they aren’t subject to the same suitability standards as typical fiduciary accounts. Many fiduciary accounts are managed conservatively (for example, a court-appointed guardian managing the assets of an incapacitated person). With a trust, the grantor can authorize different approaches in the trust agreement, including riskier investment strategies.
- 🔑 Trust accounts can also be opened as margin accounts (accounts that allow borrowing) as long as the trust agreement specifically permits it. When a brokerage firm receives a trust account application, it requests the trust agreement to confirm whether margin is allowed.
Sidenote: Delegation of duties (PMR vs. UPIA)
| Prudent Man Rule (PMR) | Uniform Prudent Investor Act (UPIA) | |
|---|---|---|
| When it applied | Before the UPIA, most trustees and other fiduciaries were regulated by the PMR | Most states adopted the UPIA in the 1990s; it’s now the general rule of law for fiduciary regulation |
| Delegation | ⚠️ Generally prohibited trustees from delegating most duties — trustees were in many cases expected to handle all aspects of trust management themselves | ⚠️ Trustees may delegate investment duties to a third party |
| Problem / change | A problem for trustees who lacked investment experience or expertise | Many PMR standards still apply, but the UPIA updated key parts of fiduciary regulation |
🔑 If a trustee hires an investment adviser, the UPIA sets these rules (word-for-word):
“The trustee shall exercise reasonable care, skill, and caution in: (1) Selecting an [adviser] (2) Establishing the scope and terms of the delegation, consistent with the purposes and terms of the trust; and (3) Periodically reviewing the agent’s actions in order to monitor the [adviser’s] performance and compliance with the terms of the delegation.”
🔑 Additionally, the UPIA creates this standard for advisers who are delegated trust assets to manage (word-for-word):
“An [adviser] owes a duty to the trust to exercise reasonable care to comply with the terms of the delegation.”
Revocable vs. irrevocable
When creating a trust, the grantor must decide whether it will be revocable or irrevocable. Each option has trade-offs.
🔑 Comparison table
| Feature | Revocable trust (living / inter vivos trust) | Irrevocable trust |
|---|---|---|
| Amendable? | May be amended during the grantor’s lifetime — the grantor can change the provisions in the trust agreement, including the trust’s objectives, trustees, beneficiaries, or even whether the trust continues to exist (it can be terminated) | ⚠️ May not be amended — the trust agreement provisions can’t be changed |
| Control of assets | Grantor retains control | ⚠️ Grantor must give up control of trust assets |
| Can grantor act as trustee? | ✅ Yes — grantors can act as trustees on revocable trusts | ⚠️ ❌ No — the grantor can’t act as trustee |
| Main advantage | Flexibility; also avoids probate | Tax-related benefits |
| Main drawback | ⚠️ Does not avoid certain taxes | Lack of flexibility |
| ⚠️ Income taxation | Investment income received by the trust is taxable to the grantor during their lifetime | The trust is treated as a taxable entity, which can shelter the grantor from taxation. If investment income is retained in the trust, it’s taxable to the trust. If it’s distributed to beneficiaries, it’s taxable to the beneficiaries. In most cases, the grantor is taxed only if they receive income from the trust |
| ⚠️ Estate taxes | Assets in the trust are subject to estate taxes when the grantor dies. Estate taxes can be substantial when they apply — an important consideration for clients using revocable trusts | Trust assets are NOT subject to estate taxes when the grantor dies. Because the grantor gave up ownership when funding the trust, the assets aren’t considered the grantor’s property at death. Irrevocable trusts can avoid significant estate taxes* |
| Gift taxes | — | ⚠️ *Although estate taxes are not a concern for irrevocable trusts, contributions made to these trusts upon creation are subject to gift taxes |
| On grantor’s death | ⚠️ Becomes irrevocable upon the death of the grantor — the trust agreement provisions may not be changed once the grantor passes away | Already irrevocable |
- 🔑 Another benefit of a living trust is avoiding probate. Assets left to a person’s estate go through probate, which can be time-consuming and expensive. Almost all trusts (except testamentary trusts) include instructions for distributing trust assets when the grantor dies.
Sidenote: Progressive vs. regressive taxes
| System | How it works | Examples |
|---|---|---|
| Progressive | Higher income generally means a higher tax rate; smaller amounts are taxed at lower rates — or not taxed at all | U.S. income taxes (lowest federal bracket 10% for low reported income; highest bracket 37% for high reported income); estate and gift taxes |
| Regressive | Applies the same tax rate regardless of income or the amount involved | Sales tax — whether you’re a billionaire or have no reported income, you pay the same percentage tax on items you buy; excise tax (a tax on a specific good, such as cigarettes) |
“An estate is the property owned by a deceased person that will eventually be distributed to heirs and beneficiaries.”
🔑 Numbers & thresholds
| Item | Exact figure / criterion as stated |
|---|---|
| Lowest federal income tax bracket | 10% (for low reported income) |
| Highest federal income tax bracket | 37% (for high reported income) |
| Federal estate tax threshold | The federal government taxes estates valued above $15 million |
| Federal gift tax threshold | Gift taxes apply only to gifts above $19,000 |
| UPIA adoption | Most states adopted the UPIA in the 1990s |
Simple vs. complex
A trust can also be classified by how it handles income distributions to beneficiaries.
| Feature | Simple trust | Complex trust |
|---|---|---|
| Income distribution | ⚠️ Must distribute investment income* to beneficiaries each year | 🔑 Defined as trusts that don’t meet the requirements of a simple trust; in particular, may accumulate investment income each year (doesn’t have to distribute income to beneficiaries annually) |
| Principal (basis) distribution | ⚠️ May not distribute principal (basis) — in fact, distributing principal terminates the trust | — |
| Taxes | Simple trusts have certain tax benefits, but 📌 you likely won’t be tested on the details | — |
*Income distributed by a trust to its beneficiaries is referred to as distributed net income (DNI).
Testamentary trusts
“A testamentary trust is created through a person’s will.”
- Many people use a last will and testament to direct how their assets should be distributed at death. With help from a legal resource (such as an estate attorney), a testamentary trust is written into the will and becomes active when the person dies. Assets designated in the will then become property of the trust.
- ⚠️ Because wills are part of estate settlement, a testamentary trust is essentially the only trust that goes through probate.
- ⚠️ Assets held in testamentary trusts are also subject to estate taxes.
| Trust type | Probate? | Estate taxes on trust assets? |
|---|---|---|
| Revocable (living / inter vivos) | Avoids probate | Yes — subject to estate taxes |
| Irrevocable | Avoids probate | No — not subject to estate taxes (but contributions subject to gift taxes) |
| Testamentary | ⚠️ Yes — essentially the only trust that goes through probate | Yes — subject to estate taxes |
Key points
Trusts
- Legal entities created to benefit a specific party
- Considered a type of fiduciary account
Trust parties
- Grantor — funds & establishes trust
- Trustee — manages the trust
- Beneficiary — receives trust assets
Revocable trusts
- Also known as living or inter vivos trusts
- May be amended during the grantor’s lifetime
- Investment income taxable to the grantor
- Becomes irrevocable upon the death of the grantor
- Trust assets subject to estate taxes
Irrevocable trusts
- May not be amended during the grantor’s lifetime
- Investment income taxable to the trust and/or its beneficiaries
- Trust assets not subject to estate taxes
Simple trusts
- Must distribute all income to beneficiaries annually
Complex trusts
- Do not meet the definition of a simple trust
- May accumulate income annually (no need to distribute)
Testamentary trusts
- Written into a person’s will
- Subject to the probate process
- Subject to estate taxes
Sources
Primary/official references for the material in this chapter. Every link was fetched and returned HTTP 200 on 2026-08-15.
| # | Source | Publisher |
|---|---|---|
| 1 | Estates and trusts — Form 1041, fiduciary income tax | IRS |
| 2 | Uniform Prudent Investor Act — portfolio-level fiduciary standard | Uniform Law Commission |
| 3 | Estate tax — gross estate, exclusion amount | IRS |
| 4 | Achievable Series 65 — chapter 2.1.4 | Achievable (course text) |
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