How Much Cash Should a Trust Hold? A Fiduciary’s Brief Intro to Liquidity Management

For fiduciaries managing assets, determining the right amount of cash to hold is a balancing act between liquidity needs, investment growth, and fiduciary duty. Too much cash can lead to eroded purchasing power over time as well as an inability to compound, while too little can lead to inconvenient selling at inopportune times. Conventional investing wisdom maintains that around a 10% cash balance is appropriate in portfolios, but there’s no universal percentage that applies specifically to trusts. Instead, it is important for fiduciaries to pay close attention to the trust agreement itself as the foundation for how liquidity should be managed.

The area of a trust agreement worth paying particular attention to is the distribution provisions, which determine how frequently and under what conditions beneficiaries receive funds. Such terms dictate whether a trust should be highly liquid or can afford to be more illiquid.

“Generous” Terms

With more generous disbursement terms, a more liquid portfolio is naturally warranted given beneficiary expectations and the anticipation of sudden corpus distributions. Language that is considered “generous” is entirely circumstantial but for all intents and purposes, I will interpret it as “a trust that serves not to inhibit, but enable beneficiary financial behavior”. For instance, what might seem like a limiting factor at face value such as annual percentage withdrawals is what I would consider “generous” given the distributions are at consistent intervals, in consistent amounts, and unwavering with regards to any behavior or spending pattern by the beneficiary. According to the Comptroller’s Handbook on Personal Fiduciary Activities, “A trust payout in the 3 percent to 5 percent range to current beneficiaries is frequently referenced as an economically sustaining, long-term arrangement” (https://www.occ.gov/publications-and-resources/publications/comptrollers-handbook/files/personal-fiduciary-activities/pub-ch-personal-fiduciary.pdf). Similarly, what might seem very nonspecific such as trusts with discretionary distributions based on a trustee’s judgment actually more often than not will result in trustee acquiescence to beneficiary whims in the name of conflict avoidance. On the extreme end of the spectrum, the trust might have no inhibitive terms on when a beneficiary can take distributions, meaning as trustee you should be prepared for sudden purchases, discretionary expenses, and imminent financial needs. Maintaining a larger cash balance (i.e. 10-20%) is appropriate.

“Restrictive” Terms

More onerous and situational terms on distributions for beneficiaries allow the trustee more freedom in investment management and consequently a decreased need for cash. In reviewing our previously defined “generous” terms, we can infer that “restrictive” terms mean something akin to “a trust that serves not to enable, but inhibit beneficiary financial behavior”. For instance, if you are managing a trust with distributions only permitted for “absolute necessary needs”, as trustee you can properly surmise that a $5mm dollar house is not covered within those terms, and still be entirely adhering to your fiduciary obligations. Other typical restrictive clauses could require beneficiaries to be fully employed before receiving distributions. In these conditions, liquidity can be managed more aggressively, with cash allocations as low as 2-5%. Age-based schedules allow you to plan around specific timeframes and manage liquidity accordingly (increasing liquidity with advancement to target distribution age).

HEMS

Trust terminology can sometimes appear opaque, so it can help to incorporate standardized provisions such as the HEMS (health, education, maintenance, or support) standard. Trustees following the HEMS standard should expect to align cash reserves with projected beneficiary needs as they relate to things like tuition payments and medical costs. These needs will of course change with time, and a HEMS trust with young beneficiaries in school may require 5-10% in cash, while one with older beneficiaries may require different amounts based on factors like medical issues.

Of course, all of these distributions should be maintained in a clear record along with how such decisions align with the trust’s purpose and prudent investment principles.