STEP Risk Assessment & Mitigation 2 — Questions and Answers
Question 1: A trustee holds a concentrated position in a single stock representing 80% of a trust's assets. Which risk mitigation strategy is most appropriate without triggering immediate capital gains?
- Immediately liquidate and diversify
- Employ an exchange fund structure (Correct answer)
- Transfer assets to a charitable remainder trust
- Request a discretionary distribution to beneficiaries
Correct answer: Employ an exchange fund structure
An exchange fund allows a trustee to contribute appreciated securities and receive a diversified interest without triggering immediate capital gains tax.
Question 2: Under the Uniform Prudent Investor Act (UPIA), which factor is NOT explicitly listed as relevant when assessing portfolio risk?
- Expected tax consequences
- The beneficiary's personal credit score (Correct answer)
- General economic conditions
- The role each investment plays within the overall portfolio
Correct answer: The beneficiary's personal credit score
The UPIA lists economic conditions, tax consequences, and portfolio role as relevant factors but does not mention the beneficiary's personal credit score.
Question 3: A testamentary trust holds real property in a flood zone. The trustee fails to obtain flood insurance and the property is destroyed. What is the primary legal risk to the trustee?
- Breach of the duty of loyalty
- Personal liability for breach of the duty of prudence (Correct answer)
- Liability for self-dealing
- Violation of the no-contest clause
Correct answer: Personal liability for breach of the duty of prudence
Failing to adequately insure trust assets against foreseeable risks constitutes a breach of the trustee's duty of prudence.
Question 4: Which type of trust structure is specifically designed to mitigate estate tax risk for married couples while retaining access to assets?
- Spendthrift trust
- Spousal Lifetime Access Trust (SLAT) (Correct answer)
- Charitable lead annuity trust
- Grantor Retained Annuity Trust (GRAT)
Correct answer: Spousal Lifetime Access Trust (SLAT)
A SLAT allows one spouse to make a gift to an irrevocable trust for the other spouse's benefit, removing assets from the estate while retaining indirect access.
Question 5: A family office identifies that a client's trust portfolio has significant correlation risk. Which approach best addresses this concern?
- Increasing allocation to domestic equities
- Adding uncorrelated asset classes such as commodities or absolute return strategies (Correct answer)
- Concentrating in investment-grade bonds
- Holding a larger cash reserve
Correct answer: Adding uncorrelated asset classes such as commodities or absolute return strategies
Adding uncorrelated asset classes reduces the portfolio's sensitivity to any single market event, directly addressing correlation risk.
Question 6: Under US law, which document most effectively protects trust assets from a beneficiary's future creditors?
- A revocable living trust
- A discretionary spendthrift trust (Correct answer)
- A totten trust
- A Totten payable-on-death account
Correct answer: A discretionary spendthrift trust
A discretionary spendthrift trust restricts voluntary and involuntary transfers of a beneficiary's interest, shielding assets from most creditor claims.
Question 7: When conducting a risk assessment for a dynasty trust, which time-horizon consideration is most unique compared to a standard trust?
- Short-term liquidity needs
- Multi-generational inflation risk eroding purchasing power (Correct answer)
- Trustee succession planning for a single successor
- Annual income distribution requirements
Correct answer: Multi-generational inflation risk eroding purchasing power
Dynasty trusts may span many generations, making long-term inflation risk a uniquely significant concern that can erode real asset values over decades.
STEP Risk Assessment & Mitigation 2
A trustee holds a concentrated position in a single stock representing 80% of a trust's assets.
Which risk mitigation strategy is most appropriate without triggering immediate capital gains?