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From Friend to Fiduciary – Understanding Fiduciary Duties

Like so many concepts in the law, the word “fiduciary” has Latin roots; it means trust. This is particularly appropriate as the word trust is thought of as the confidence and reliability required in a person of great importance – as well as a legal vehicle to develop such relationships.

The list of potential fiduciary positions is rather long, demonstrating that it is quite easy to become a fiduciary for another person. While a fiduciary can be a stock brokerage firm handling the investments of a retiree or a real estate agent selling a home for a client, in the estate planning and elder law context, a fiduciary very commonly comes in the form of a trustee of a trust, an agent in a power of attorney, or as an executor of a will.

When Does One Become a Fiduciary?

A fiduciary relationship is developed whenever a person agrees to take on that role, or is appointed to the role by a judge or other legal document. From that point forward, until the end of this relationship, the fiduciary is obligated to perform in the best interest of the principal. Fiduciary relationships can develop when a person or other entity, typically with superior knowledge or experience in a certain area, agrees to manage tasks for another person. However, one with no experience or specialized knowledge of certain tasks can commonly become a fiduciary for a loved one. It is important for this new fiduciary to understand their important role, and the risks that come with it.

For friends, family members, or designated entities, fiduciary relationships often arise through a will provision or other estate planning documents. Thus, at the passing of the principal, the designated person agrees to take on the role of trustee/administrator/executor/ etc. and the fiduciary relationship begins. This role may end once beneficiaries reach a certain age, through a court order removing them from the position, by completing the tasks assigned, or by a specified termination date within the creation document.

Fiduciary-DutiesWhat Are Fiduciary Duties?

Because of the special relationship between a fiduciary and the principal that they act on behalf of, there is a significant risk for abuse and misdeeds performed by a fiduciary. For this reason, the law imposes a high burden of care for fiduciaries to manage tasks for the principal. At the acceptance of the fiduciary relationship, the fiduciary becomes legally obligated to act on behalf of the principal. These actions must be reasonable and in the best interest of the principal, or for the beneficiaries for post-death arrangements of the principal.

Duty of Loyalty

A fiduciary owes a duty of loyalty to the principal or beneficiary. This means that the fiduciary must always act with the best outcome for the principal or beneficiary in mind. A fiduciary may not act with their own interests in mind, and must keep the trust assets separate from their own.  A fiduciary cannot loan money to themselves.  Any compensation that a fiduciary takes must be above the board, with all parties consenting to a reasonable amount. 

Duty of Care

A fiduciary owes a duty of care as well. This principle is intended to prevent unreasonable actions by the fiduciary. In other words, the fiduciary may not take unreasonable risks with the assets that may create a likelihood of diminishing the estate. Also, a fiduciary must take and keep detailed records regarding the assets under their charge, and avail these records to those with whom they have the fiduciary relationship.   

Duty of Prudence

Although a guarantor relationship is not created when a fiduciary is managing assets, that fiduciary must manage and invest those assets in a prudent manner.  Sound investments must be made.  Taxation, inflation, capital return, and the need for liquid assets must be considered.  A fiduciary must preserve, protect, and grow trust assets in a wise and sensible way. 

Breaching the Fiduciary Duty

There are many ways in which a fiduciary may violate their duties. Failing to maintain accounts, not paying estate and income taxes on behalf of the principal, allowing insurance to lapse, favoring certain beneficiaries over others, or being reckless or too conservative with investments are common examples of potential breaches.

When any fiduciary violates their established duties, they risk personal liability for the degradation of the estate they agreed to protect. When an attorney breaches these fiduciary duties, they also risk malpractice, disciplinary action, and even disbarment. Courts take the trusting bond between fiduciary and principal very seriously.

Considerations When Advising Clients

Senior adult couple meets with financial advisorAn elder law client may need guidance on who to choose to serve as a fiduciary. Explain to them why the fiduciary they choose for their healthcare power of attorney should be given different consideration than who they choose as the executor of their estate. Fiduciaries serving in various roles might draw on different skill sets and passions, and have more commitments than others. 

Many clients underestimate the amount of time and knowledge one may need to be an effective fiduciary.  Choosing a child or cousin might seem appropriate, as they are already trusted by the client.  Also, the client might feel obligated to select family members.  However, does that family member have the expertise needed to invest and manage assets?  Do they have the time to commit to it?  It can be very helpful to have the client speak with that family member, before selecting them, and make sure the family member is up to the task. 

Finally, when selecting a fiduciary, it is very important to analyze whether an independent or interested fiduciary is best for each role.  An independent trustee would be one who is not the grantor, nor is a related or subordinate party to the grantor, the grantor’s spouse, and is not a beneficiary of the trust, within the meaning of IRC Section 672(c).  An independent trustee may provide more benefits to a client.  For example, in the EC Medicaid Asset Protection Trust®, an independent trustee may distribute to a lifetime beneficiary for any reason with no adverse tax consequences for the trustee.  Also, an independent trustee can give completely discretionary distributions, which offers more protections to beneficiaries with creditor problems.  In practice, an independent trustee is often a retired accountant or attorney, family friend, or corporate fiduciary. 

Overview

Whenever a person takes on the role of managing another person’s affairs, it is important to remember that the fiduciary must act in the best interest of the principal or their beneficiaries. Fiduciaries are created via wills, power of attorneys, and other various means. Mismanagement by a fiduciary may result in personal liability. Lastly, states may vary on rules and expectations of fiduciaries, so become familiar with your jurisdictional rules. Despite strict rules and potential hazards, acting in a fiduciary capacity can be very rewarding – fiduciaries receive the honor of acting out the wishes of a loved one or valued client.

EC Medicaid Asset Protection Trust Document Preview

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