Consider the following two scenarios:
- You create a family trust to provide for your surviving spouse when you pass away. When she dies, any assets remaining in the trust will pass on to your children, who are from a previous marriage.
This can create tension between your surviving spouse who desires to receive as much income from the trust as possible and your children who wish to maximize their inheritance by allowing the trust assets to appreciate as much as possible.
So, is there any reasonable way for the trustee to satisfy both your surviving spouse’s wishes and those of your children who will eventually inherit the trust assets?
- You have a daughter who has never been able to keep a job and you want to provide for her in a trust. However, you also want to ensure that the trust will provide income to your daughter for the rest of her life, which can be for another 30 or 40 years.
How can the trustee distribute income to your daughter so that the trust is not exhausted prematurely? Is there a way you can create the trust so that your daughter cannot pressure the trustee into making greater or more frequent distributions and, thereby, jeopardizing her future financial security?
In both of the examples above, a particular type of trust referred to as a unitrust can be used to accommodate both the need for income and asset accumulation—two very disparate financial goals.
Current Beneficiary vs. Remainder Beneficiary
Before getting into what a unitrust is, it is important to introduce and explain the difference between a current beneficiary and a remainder beneficiary. A current beneficiary (previously referred to as an “income beneficiary”) is one who receives the income generated by the trust assets. A remainder beneficiary inherits the trust assets when the current beneficiary’s dies or his or her interest in the trust terminates.
For instance, a family trust might be created to provide income to your wife after you pass away (the current beneficiary). Then, when your wife dies, the assets remaining in the trust will pass on to your children (the remainder beneficiaries).
Traditionally, most family trusts were created like the example above, i.e. with an “income beneficiary” and a remainder beneficiary. The assets in these trusts were then typically invested for yield and income to provide immediate cash flow.
This investment approach clearly favors the best interests of the income beneficiary over the interests of the remainder beneficiary. But, if the investment approach for such a trust were to be switched from yield and income to long-term appreciation (which would then favor the remainder beneficiary) what kind of income distributions could the current beneficiary expect to receive?
As you can see, a trust that is created in this way automatically pits the interests of the current beneficiary against that of the remainder beneficiary, or in the case of a family trust, one generation against another. Enter the unitrust.
What is a Unitrust?
A unitrust, which is created either at the same time the trust is created or later by converting an ordinary trust, is one that pays out a fixed percentage (3-5% for example) of the fair market value of the trust principal to the current beneficiary. This allows the interests of the current beneficiary and the remainder beneficiary to be aligned.
With a unitrust, both the current beneficiary and the remainder beneficiary benefit from the appreciation of the trust assets. This is because the greater the fair market value of the trust principal, the greater the income distribution to the current beneficiary. So, in theory, any conflict of interest has been eliminated.
In those years when the income generated by the trust assets is insufficient to fund the percentage to be paid out to the current beneficiary, the trustee can liquidate assets to make up the deficiency. In years when the income generated from the trust assets exceeds that which must be paid out to the current beneficiary, the excess income will be added to the trust principal, thereby increasing the fair market value of the trust.
What is Total Return Investing?
With a unitrust, the trustee is free to invest the trust assets in a way that maximizes the trust’s market value. The investment approach most often associated with unitrusts is referred to as Total Return Investing.
With the income approach, the trustee only considers the amount of income the trust assets are generating. With total return investing, the trustee is also concerned with capital appreciation if the trust assets.
Total return investing gives the trustee much more flexibility and lowers investment risks when trying to maximize income. This, in turn, allows for a more efficient and diverse portfolio than the income approach alone, which often forces the trustee to accept more risk when investing the trust assets for greater yield and income.
For more detailed information on the advantages of trust planning with a unitrust and to find out if a unitrust is right for your estate planning needs, consult with an experienced trust and estate planning attorney in the state where you live.
Consult with an Experienced Estate Planning Attorney
When drafting a trust, you should always enlist the assistance of a qualified estate planning attorney. An experienced estate planning attorney can help you avoid many of the problems that can render your trust ineffective or useless. For more information, contact us or sign up below for one of our events.