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New trusts may help reduce confusion

Designing a trust for your family

Often, one of the objectives of a trust-based financial plan is to separate the benefits of property ownership into current and future portions.

In a marital deduction trust, to take a routine example, a surviving spouse must have the right to all the trust income, paid at least annually, and in the future, after that spouse’s death, the remaining beneficiaries (typically, the children or grandchildren) will receive what is left in the trust.

Measuring “income”

But that phrase “all the trust income” can be a source of surprising contention. Traditionally, trust income consists of dividends and interest.

Capital gains and losses affect the amount of principal and, therefore, accrue to the beneficiaries. So, should the trustee invest for maximum growth, for maximum income or for some of each?

When stock prices are shooting up and dividends are not keeping pace (as happened in the 1990s), finding the right balance may be tricky.

If you add to the mix the relatively low interest that we’ve experienced over the last few years, it becomes even harder to wring an income consistent with beneficiary expectations out of a portfolio.

In recent years new trust forms have emerged that try to reduce the potential for conflict between income and remainder beneficiaries over a trust’s investment policy.

Called a total return trust or a private unitrust, this approach calls for paying the income beneficiary a fixed percentage of the trust’s value, determined annually.

If stock prices move higher, the income beneficiary shares in that good fortune.

This approach frees the trustee to invest trust assets for total return, a direction that trustees have been encouraged to take by changes around the country in state laws governing fiduciary investing.

IRS regulations recognize this approach as well.

The question of flexibility

There isn’t as much flexibility in setting the payout rate for a total return trust as one might surmise. Set the rate too low, and the income beneficiary won’t have enough to live on. Set it too high, and there is a real risk that the trust will be depleted, leaving nothing for the remaining heirs. That’s why some planners are uncomfortable with the inflexibility of the total return format.

Volatile financial markets can have unwanted effects on fixed formulas. For that reason several alternative approaches also have been developed for balancing the needs and meeting the expectations of beneficiaries from multiple generations.

The following table briefly summarizes some of the many strategies that have emerged to balance the interests of current and future beneficiaries.

Jeff Francis is vice president and senior investment officer for First Tennessee Brokerage. For more information about this and other personal finance issues, call 865 971-2321.


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