What Your Estate Plan Should Consider in a Low Yield Environment

In many ways your estate plan intersects with a variety of disciplines. Legal and tax considerations are the first ones that come to mind, but there are others, such as finance, economics, and family dynamics. All play an important role determining the success or failure of your plan.

Consider, for example, a trust for your surviving spouse. Typically, these trusts provide income to her, with principal invasions as necessary for her health, maintenance, and support. In today’s low yield environment, however, let’s an income/discretionary principal trust isn’t your only option and may not be the best way to provide for her and your children.

Let’s say that William has a trust with $1.5 million of investments at his death, and that his wife, Janet, is to receive the income earned by the trust. In our current low yield environment, if the trustee invested the assets following William’s death into a conservative, income producing portfolio, the yield might be three percent (3%) to four percent (4%) at best. That equates to only $45,000 to $60,000 of annual income, equating to a range of $3,750 to $5,000/month.

That might not be enough for Janet’s needs. But let’s consider the trustee’s duty to not only invest for the income beneficiary (Janet) but for those remainder beneficiaries who receive after Janet’s death (William’s children). If the trustee balances both needs equally, then the trustee will split the investment portfolio, half into income and half into growth.

Consequently, Janet’s income might be halved. This means that her likely income would range from $1,875 to $2,500/month. This looks pretty bleak, doesn’t it? Even if Janet is acting as trustee for William’s trust, she has a fiduciary duty (absent any language in the trust document to the contrary) to impartially balance her needs with those of the remainder beneficiaries.

If the remainder beneficiaries are the children of William and Janet’s marriage, then they would likely tell their mother to consider her needs without considering theirs. But what if the children aren’t so generous? What if William’s children are stepchildren to Janet? Would they demand that the trustee, whomever that may be, to consider their needs as well?

Quite the conundrum. But there’s an answer.

It’s called a “total return unitrust.” This type of a trust distributes a set percentage to the income beneficiary, regardless whether that percentage comes from income, capital gains, or the corpus (principal). In my previous example assume that William establishes a 5% total return unitrust for Janet. Here, she’s going to receive $75,000 annually equating to $6,250/month.

Should William’s children be happy with this result? You might believe this counterintuitive until you consider that the trustee no longer must concern itself with whether it invests in income or growth assets. Instead, the trustee’s investment goal will be to outperform the 5% distribution. In today’s market, that should be attainable, even with conservative investments.

This means two things: First, growth for the remainder beneficiaries. Good for them. Even better, the total return unitrust is recalculated annually. So long as the trustee outperforms the distribution percentage, Janet’s income will increase.

Again, let’s turn to an example. Let’s say that the trustee achieves a 11% return on the $1.5 million trust. That’s $165,000. It distributed $75,000 to Janet during the year. The trust has net growth of $90,000, so the end of year balance is $1,590,000. (Note to reader – I’m intentionally omitting income taxes from the calculation to make the math easy.)

In the next year, Janet receives 5% of $1.59 million, increasing her annual income to $79,500, translating to $6,625/month. Janet’s happy with increased income. William’s children are satisfied that the trust is growing for their benefit as well.

What do we do about trusts that are now irrevocable, but they’re income trusts? Is it possible to convert the trusts of our deceased relatives to a total return unitrust?

Yes! Florida law allows a trustee to convert an otherwise irrevocable trust to a total return unitrust. There are specific requirements that must be satisfied. If you care to look them up, see Florida Statutes Section 738.1041.

If this interests you, seek the advice of a qualified wills, trusts and estates attorney. Know that there are options available, even within this strategy, and that here I’m breaking down a complex subject into a short column. I don’t have room for the important details every family should consider. But it’s good to know that this strategy exists both for your lifetime planning, and if necessary, post-mortem planning.

©2021, Craig R. Hersch. Learn more at floridaestateplanning.com

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