Many trusts created in the past were set up as ‘income-only” trusts in which the net income would be payable to the beneficiary during lifetime or during the term of the trust. A typical example of such a trust would be the QTIP Marital Deduction Trust set up for a surviving spouse. Given the modest levels of interest and dividend income collectible today, many beneficiaries, Trustees and investment advisors seeking more flexible and equitable ways of administering otherwise irrevocable trusts have discovered the benefits of the Unitrust. More and more jurisdictions have gradually over the last 12 years passed enabling statutes authorizing the use of such trust in a variety of circumstances.
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In New York, the applicable trust administration statute provides that an “income-only” trust may be converted either to a “Statutory Unitrust” or a “Power-to-Adjust Unitrust.” With a Statutory Unitrust, an amount equal to 4% of the value of the trust as of the first day of each year would be distributed to the income beneficiary during that year. After three years of administration, the values of the trust assets in the preceding three-year period are averaged so that the percentage is applied to a rolling average. In the case of a Power-to-Adjust Unitrust, the Trustee (rather than the New York Statute) would determine an appropriate distribution percentage at the outset of every year based on the economy and the investment outlook, as well as the circumstances of the income beneficiary and/or remaindermen.
The Unitrust statutes first became effective in New York in 2002. Since then, more and more Trustees have elected to convert income-only trusts to either a Statutory Unitrust or a Power-to-Adjust Unitrust. Generally, Trustees seem to favor the Power-to-Adjust Unitrust because it is more flexible and would not involve a filing with the Surrogate’s Court. The annual distribution percentage used in a Power-to-Adjust Unitrust can also be applied to a three-year rolling average of the trust values in order to smooth out the peaks and valleys for the lifetime beneficiary. The IRS “safe harbor” for Unitrust percentages fixed by the Trustee is in the 3-to-5% range. This year, most professional Trustees that I am aware of are exercising the Power-to-Adjust to fix the distribution percentage for 2011 at somewhere between 3% and 3.25%, feeling that this percentage best balances in a typical trust the desire of the lifetime beneficiary for cash flow (income) and the expectations of the remaindermen for future appreciation in the portfolio.
Among the benefits of the Unitrust (Statutory or Power-to-Adjust) are the following:
A. The Trustee and the income beneficiary will know at the beginning of the year the precise amount that will be distributable in the course of the year, and can set up automatic monthly or quarterly distributions in a uniform amount.
B. The Trustee can invest for “total return” in the portfolio, without being obliged to focus on the production of a projected amount of interest or dividend income to be collected for distribution net of expenses payable out of trust income. A total return investment approach is thought to have more flexibility for investment professionals seeking a broad diversification of investments in the trust portfolio.
C. The interests of the life beneficiary and the remaindermen are aligned when a trust is administered as a Unitrust. As the value of the trust increases, the annual distribution amount for the life beneficiary would increase and the amount of principal on hand at the end and ultimately available for the remaindermen would increase. This is not always the case when a Trustee is focused on the production of a certain amount of net income for the lifetime beneficiary.
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The laws of many other states, including Connecticut and Virginia, today authorize Trustees to convert certain existing income-only trusts to Unitrust administration. Each state has rules for accomplishing this conversion, sometimes requiring a Court filing and sometimes, as in the case of the New York Power-to-Adjust Unitrust, a document signed by an independent Trustee with the consent of the interested parties.