Any time someone takes on a fiduciary duty, there is risk involved.
Financial advisors’ risk will very. Trust assets offer an opportunity for advisors to further assist their clients. Often, advisors will be asked to manage trust assets of a client or assist in the process of estate planning.
The two main types of trusts are delegated and directed. It is important for advisors to understand the risks they face with each type.
This article will highlight the financial advisor risk faced when a client needs trust management.
Financial Advisor Risk on a Delegated Trust
Delegated Trust Benefits
Financial advisor risk is shared if there’s an advisor-friendly trust company. A delegated trust gives the power to the trustee to delegate who invests the trust assets.
This does not mean that a trustees no longer responsible for the investment of the trust assets. The trustee still has a role to make sure that the investment manager they have chosen is following the fiduciary standard.
If the trust is delegated, both the trust company and advisor share the risk. This only occurs when you are using an advisor-friendly trust company.
If you're using a bank or traditional trust company, the investment management is done in-house. This gives clients fewer options for who they want to manage their assets.
Delegated Trust Risks
Although there are many benefits to delegated trusts, advisors need to understand the risks.
One important factor for the financial advisors’ risk is who their client has chosen to serve as trustee. If you have a client who has picked a traditional trust company, understand that you as the advisor will be replaced for investment management services.
There’s risk even when using an advisor-friendly trust company. Some trust companies eliminate their financial advisor risk by making advisors use their model portfolios or their custodians.
They will require separate trust custodial accounts for distributions, but not all advisor-friendly trust companies are like that. For example, Wealth Advisors Trust Company does not do this because it does not reduce financial advisor risk and it increases workload.
Advisors in transition also face risk when they need to change a trustee. The trustee delegates the advisor to be the investment manager, but the trustee may delegate someone else if the advisor makes a change.
Financial Advisor Risk on a Directed Trust
Directed Trust Benefits
Directed trusts separate the investment management from the trustee, similar to delegated trusts.
The difference is that a common trust holds the trustee responsible for trust administration and investments.
A directed trust allows the creators of the trust to “direct” who will be the investment management.
Directed trusts offer grantors more control. This lowers the risk of the trustee because they are not choosing the investment manager.
The benefits for the advisor occur when they're named in the document and they then remain a legacy advisor. This reduces conflict and makes it easy for both parties to do their job.
Directed Trust Risk
There are risks with directed trust for advisors, trustees, and also clients.
First, if the grantor has named an advisor to manage the trust assets, that advisor must thoroughly understand their contingency plan. It is important understand if that advisor will still be around when the trust assets need to be managed.
Second, is there removal and appointment language in the trust document? If the trustee or advisor is doing an egregious job, they should be able to be replaced.
Third, all fiduciary risk for investment management is directed onto the advisor. The issue of informing a financial advisor of their risk with directed trust is not commonly done in the trust industry.
Today, advisors and clients have more options then ever before. Whether your client is using a directed trust or a delegated trust, it is important to understand the risks for the financial advisor.
To learn more about delegated and directed trusts, read our thorough guide for yourself.