When it comes to trusts, income beneficiaries and remainder beneficiaries typically have competing interests. Income beneficiaries usually want the biggest current distribution, while remainder beneficiaries prefer to protect and preserve trust assets so they will inherit more money in the future.
The income beneficiary, who is typically the surviving spouse, may also request principal distributions in addition to income distributions. The remainder beneficiaries, who are typically the children or the grandchildren of the grantor, have a financial interest in ensuring that as much of the trust balance remains intact as possible for ultimate distribution to them. The trustee is often placed in a position to balance these conflicting interests, which can be a delicate balancing act.
A unitrust, which is a type of irrevocable trust, offers a pre-set percentage of the trust’s assets to be paid out to the income beneficiary (also known as a lifetime beneficiary) annually while preserving and growing the portfolio for remainder beneficiaries. A unitrust ensures that the income beneficiary receives a set percentage of the net asset value (NAV) of the trust, which is calculated annually, rather than paying out the net income earned by the trust which will fluctuate from year to year. Ideally, over time, the unitrust will be able to increase annual payouts and grow the principal.
Unlike a traditional trust, which requires the trustee to focus on generating income through dividends and interest, the unitrust can give your lifetime beneficiary a higher withdrawal rate while investing trust assets for growth that will benefit your remainder beneficiaries. A unitrust can be a smart option from an investment standpoint because it frees the trustee to invest for both income and growth, allowing for a more diversified portfolio that can more easily address market fluctuations, inflation, or other risk factors.
Traditional trusts that distribute the net income to beneficiaries will usually have principal encroachment provisions. If income beneficiaries need additional funds – to purchase a home, start a new business, or buy a car, for example – they can appeal to the trustee for a principal encroachment, which is essentially a large, unanticipated, unscheduled payout from the trust assets. Because a unitrust, by definition, doesn’t allow for principal encroachments, it can be highly strategic in certain situations, particularly if the grantor is making sure that the bulk of the trust assets pass to remainder beneficiaries.
One major challenge with traditional trusts is that trust income can fluctuate dramatically depending on the economic climate, stock market performance, interest rates, and other factors. When interest rates are low, lifetime beneficiaries may see their income reduced. The unitrust provides income beneficiaries with a more consistent, predictable, percentage-based distribution amount that isn’t tied to the income produced by trust assets.
For example, if the grantor established a $1 million unitrust with a 4% payout for a spouse, the beneficiary would receive $40,000 in the first year, with larger distributions in subsequent years as the principal grows over time. A traditional trust, on the other hand, might only be able to generate half that amount, particularly in a period of low interest rates.
With the unitrust, income and remainder beneficiaries share the same goal: increased portfolio value. The greater the portfolio growth, the larger the 4% payout becomes and the bigger the remainder assets will be in the future.
Ideally, a unitrust investment portfolio should be invested for total return, meaning that income-oriented and growth-oriented investments alike can populate the portfolio. Assuming a long term rate of return of 8%, the portfolio will cover the 4% payout to the income beneficiary and provide additional opportunities to invest the remaining balance to generate long-term growth.
How do you know if a unitrust is the right choice for you and your family? Like any trust, a unitrust can make sense if you have at least $500,000 in assets. It can also be a good choice if you’d like to provide for your second spouse long-term, while making sure that your children and other remainder beneficiaries will receive the balance of the trust assets following the death of the lifetime beneficiary. A unitrust might not be appropriate if you think your spouse will need principal encroachments above the specific payout.
Like any trust, a unitrust is a legal arrangement wherein property and assets are held, managed, and invested by a third party for the benefit of one or more beneficiaries. A professionally managed portfolio can make sure assets are invested strategically and preserved for the next generation.
Remember that trust planning can help to protect your family relationships and minimize fights over money. Because it’s extremely difficult to break a trust in Georgia, a trust can ensure that your wishes will be honored and your assets will be managed and distributed in accordance with your legal directive.
The time to set up a unitrust is when you’re healthy, strong, and of sound mind. An estate planning attorney should always be part of the process, making sure that your trust is set up in full compliance with state laws. Bringing your financial advisor into the unitrust drafting stage can be beneficial to help you achieve your goals and to ensure that your surviving spouse, your children, and any other designated beneficiaries will benefit from your generosity, in accordance with your wishes.
Do you need help setting up a unitrust or determining if this trust option makes sense for you and your family? Please reach out to us to get started. We’re happy to help at any point.