A Practitioner’s Guide for Executing Trust Termination

A Practitioner’s Guide for Executing Trust Termination

The Estateably Team
October 12, 2023

Trusts aren’t meant to last forever. It's important to understand that they have a finite lifespan and can be terminated for various reasons, such as reaching the end of the term or due to unforeseen circumstances. Properly closing a trust requires adherence to the trust document, state and federal laws, and fiduciary responsibilities.

In this guide, we’ll examine the process of terminating a trust in detail, including reasons for termination, fulfilling obligations, and best practices to ensure a smooth and successful conclusion.

Understanding Why A Trust May Terminate

There are several reasons why a trust might need to terminate, which isn’t surprising when you consider the many different types of trusts.

At its simplest, a trust is a legal arrangement where one person (the trustor or grantor) hands over assets or property to someone else (the trustee) to manage on behalf of a third party (the beneficiary). Generally, they fall into two main categories:

  • Revocable trusts: Allow the trustor to make any changes during their lifetime while they’re competent. They become irrevocable after the trustor's death.
  • Irrevocable trusts: Cannot be amended except in a limited range of circumstances. Testamentary trusts, which contain the trustor’s assets as listed in their last will and testament, become irrevocable after their death.

However, some trusts cover various purposes within these broad categories and will result in the termination of a trust. Let’s take a closer look at some of these.

Expected Circumstances That Result In Trust Termination

Sometimes, a trust comes to a natural end. Common reasons for this include:

Age or Date Triggers

Often, the terms of a trust dictate when the beneficiary receives the assets. It could be when they turn 18, 21, or even 35. The trustor might also specify that the property will be distributed in stages. Whatever the final milestone, this type of trust is terminated when the beneficiary reaches a specific age. Similarly, the terms of the trust might define a certain date, after which the trust terminates.

Event Triggers

A certain event can also trigger a trust’s termination. For example, the beneficiary might be in line to receive the assets when they graduate from high school or college, when they get married, or after the birth of their first child. However, this could be considered invalid if it places unreasonable restraints on the beneficiary. The death of a life tenant is another event that might dissolve a trust.

The Trust Has Done Its Job

Sometimes, a trust is terminated because it has done what it intended. A trust, created after the death of a grantor of a revocable living trust, whose purpose is to distribute the (previously revocable trust) assets to beneficiaries, for example, is terminated when the trust assets have been valued, the debts and taxes have been paid, and the trust property has been distributed to the named beneficiaries.

Unplanned Circumstances That Lead To Trust Termination

Even the most meticulous trustor can’t see into the future, and changed circumstances can lead to a trust’s termination. It could be down to the death of a beneficiary or the trustors getting divorced. Here are a few more unanticipated reasons why some trusts terminate early:

The Cost of Running the Trust is Too High

Every trust involves administration costs. Over time, these costs can overtake any income earned from its investments. In general, a trust doesn’t have unlimited funds. Once the trust property has dipped in value to the extent that it’s no longer economically feasible, the beneficiaries might seek a termination.

The Trust Has Been Contested

Sometimes, trust beneficiaries or other stakeholders make a complaint or raise a dispute which goes to court. When this happens, the court might decide to terminate the trust and order the immediate distribution of the assets. They might also order the terms to be modified, a new trustee to be appointed, or that property is placed in a new trust altogether.

Legal Reasons

While the trustee must honor the trustor's wishes, the court might decide whether the trust is illegal or invalid. A trust is illegal if designed for defrauding creditors, operating an illegal business, or depriving a spouse of their rightful elective share. It's also crucial that trust creators are legally competent. If that's not the case, or if the trust was created through fraud or under duress, the trust is considered invalid.

Why Does Proper Trust Termination Matter?

When a trust has served its purpose, it’s essential to terminate it properly. Administering a trust is subject to various financial and legal regulations, and trustees can be personally liable for any errors. So it’s crucial to manage the process correctly to avoid consequences such as legal challenges, disputes among beneficiaries, tax liabilities, and financial losses.

Some of the most common tripwires? Failing to pay taxes or file financial records on time, making unwise investments on behalf of the trust, self-dealing, or neglecting assets (for example, not keeping up with property insurance payments) can all lead to complaints and even litigation.

Understanding the Vital Role of the Trustee

A trustee’s overarching responsibility is to carry out the wishes of the trustor or originator in line with the terms of the trust (except, of course, where it doesn’t comply with the law). So in the case of a discretionary trust, for example, the termination is down to the trustee’s absolute discretion, and they can choose to wind down the trust and distribute all the assets in a way that aligns with the trust instrument.

How To Prepare For Trust Termination: Knowing the Legal and Administrative Requirements

A trust doesn’t simply stop automatically, even if planned events have triggered the termination. First, let’s look at who can terminate a trust or petition for a judicial termination. While this might be down to the trustee, the decision doesn’t always lie with them. Other interested parties, including the trustor, beneficiaries who might be contesting the trust, or third parties who would be negatively affected, can also terminate a trust.

No matter which party is terminating a trust, it’s generally best to put your intention in writing so that everyone involved has a clear record. You may or may not need court approval, depending on the type of trust, state regulations, and the value of funds or property in the trust.

Valuing Trust Assets and Distributing Trust Property

One of the most critical tasks in terminating a trust is valuing and distributing its assets. In some locations, you might need to file a petition before making the distribution.

Beneficiaries can complain if they feel that assets haven’t been properly managed, such as if a property has fallen into disrepair or if assets haven’t been valued correctly. So if you’re selling property, jewelry, or other valuables on behalf of a trust or estate, it’s crucial to have them appraised by an expert before you do so.

It’s also crucial for a trustee to manage investments responsibly and steer clear of self-dealing (buying a trust’s assets yourself) to stay on the right side of regulations and avoid potential disputes. Assets should be distributed among the beneficiaries fairly and in line with the trust's original purpose. The trust is considered terminated when this has been done.

Resolving Outstanding Debts and Taxes

One of the most important duties of a trustee is to make sure that outstanding debts are resolved before the assets are distributed. You’ll also need to file a final tax return on behalf of the trust and pay off any due taxes. This could include rental income, dividend payments, valuables or other property sales, or interest the trust receives during the administration period.

Finally, it’s good practice for any trustee to keep back a reasonable contingency to cover any further taxes or expenses that may crop up.

Addressing Potential Conflicts and Disputes

A conflict or a dispute between a trustee and a trust beneficiary or other interested party can derail the administration or termination of a trust or even see it dissolved by the court. So, what can you do to head these off?

It pays to keep meticulous records throughout the process. Make sure to document everything, from phone calls to financial transactions, and digitize and organize your documents to always have the relevant information when needed. That way, you can respond to queries promptly and reassure beneficiaries that you’re properly managing the trust and termination process.

It should go without saying that everything should be done in line with the applicable legislation. Whether creating forms and letters in the correct, court-approved format or submitting financial reports on time, compliance with legal and financial regulations will help you avoid potential conflicts and disputes.

Closing Out Trust Accounts and Records

On the termination of a trust, the fiduciary has to be discharged by the trust’s beneficiaries or the court. Depending on local laws, you might need to do this via a formal process involving filing a petition in court and submitting a final accounting.

Even if this isn’t a legal requirement, it’s worth ensuring that the beneficiaries sign a document to confirm that they approve of how the trust has been managed and that they have received the funds or property they were due. This will help protect you from legal claims in the future.

The trustee should also file a final tax return on behalf of the trust and keep back a reserve to cover any taxes or expenses.

Communicating A Trust Termination To Beneficiaries and Other Stakeholders

When closing out a trust, a dispute with beneficiaries or other stakeholders, such as financial advisors or accountants, can throw a spanner in the works. So it’s important to take a proactive approach to communication.

Keep beneficiaries regularly updated regarding the progress of the trust termination, recent financial activity, and when they can expect to receive any assets they’re due. Beneficiaries should also be made aware of any impact the termination might have on their rights and tax implications. By helping them avoid surprises, you can mitigate the risk of them making a complaint or going to court.

It’s also good practice to wrap everything up with a final accounting and a letter summarizing the trust’s income, expenses (including fees and taxes), and asset distributions.

Streamline Your Trust Termination Process with Estateably

As we’ve seen, meticulous accounting, accurate records, and regular beneficiary communication are crucial to the smooth termination of a trust. It’s no wonder law firms are turning to software to help administer the process more efficiently.

Estateably is the first cloud-based system for trust and estate professionals in Canada and the United States. Our intuitive platform streamlines many administrative tasks associated with terminating a trust, from document management to accounting. And with built-in compliance, our software makes it easy to ensure you meet all your legal and administrative requirements.

Are you looking for a new way to close out trusts more efficiently in your practice? Our team is here to help. Contact us to learn more about our solution, or request a demo to see our software in action.

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