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Living Trust Investing: Income Considerations When The Grantor Dies
By: Glenn
A common problem I often see when working with living trust beneficiaries and
trustees is the lack of attention in rethinking income strategies in the event
of the grantor's death.
When the grantor of a living trust dies, the trustee (especially a family member
or close friend) sometimes feels reluctant to revise the portfolio, feeling it's
an affront to the wishes of the deceased. After all, if the investments were
sound during life, they should be sound enough upon his or her death.
While the fundamental values of the investments are certainly the same, a number
of circumstances have changed and must be dealt with.
The most crucial change is because of the trust itself. There are sections
within the trust instrument that deal with income distributions, both during the
grantor's lifetime and after his or her death. The trustee should become
familiar with these sections and how their differences will have an impact upon
investment decisions.
Secondly, with the passing of the grantor, new assets (such as life insurance
death benefits) are often added to the trust assets and these new assets must be
invested in a way that complies with the grantor's wishes.
Thirdly, assets held outside the trust often need to be considered. For example,
the grantor may have held qualified retirement plan benefits that are passed
directly to a trust beneficiary. Utilization of these retirement benefits may
need to be recognized and, in some instances, may even be discussed in the trust
instrument.
Lastly, the trust beneficiaries may have assets of their own and these asets
should be brought into the mix of things.
When revising an investment strategy, the needs of the income beneficiaries are
a good place to start. First, determine available cash flow from sources outside
the trust. Typically, this could include Social Security benefits, immediate
annuities, deferred compensation, qualified retirement plans and, of course, the
beneficary's own assets.
Next, fund whatever income deficit is left by assuming a modest rate of yield in
the trust. Hopefully, this modest amount will satisfy the needs of the income
beneficiaries. If not, you can raise the yield somewhat, but not too much. At
some point, you'll reach beyond what yield can be readily achieved with an
acceptable risk level, to speak nothing of breaching the trustee's
responsibility to act in a prudent fashion.
Because the trustee has a responsibility to all beneficiaries, including those
who may ultimately inherit the trust, it may be necessary to balance the income
needs of the income beneficiaries and the growth needs of the ultimate
beneficiaries. This fidicuary role is paramount to the decisions made by the
trustee.
It is also important to note the difference between "yield" and "total return,"
as applied to a trust. Total return includes capital gains, but those gains are
often excluded from the definition of "distributable income" in a trust.
Distributions that exceed income will be construed as principal and are often
left to a trustee's discretion. A trustee can say "no" as easily as "yes" to
principal distributions.
If principal distributions are left to the trustee's discretion, it's a good
guess that the intent was not to punish the beneficiary, but to keep the trust
out of the beneficiary's taxable estate.
Carrying this one step farther, many financial advisers will argue that, if a
beneficiary's own estate is large enough to be exposed to estate taxes, then the
beneficiary might be wise to "spend down" his or her own estate and let the
trust grow in value.
The inverse is also true. If a beneficiary has a small estate, then he or she
may want income from the trust, but he or she may also want the principal to
grow in his or her own name so as to get a stepped-up tax basis upon death.
These strategies are very common if the ultimate beneficiaries are the same
people.
The role of the trustee can be difficult, but paying attention to the changes in
income needs will avoid future problems and inefficiencies in carrying out the
duties of administering the trust.
Copyright 2005. LivingTrustNetwork, LLC. All rights reserved.
About the Author:
Glenn (“Chip”) Dahlke, a senior contributor to the Living Trust Network (http://www.livingtrustnetwork.com),
has 28 years in the investment business. He is a Registered Representative of
Linsco/Private Ledger and a principal with Dahlke Financial Group. If you have
any questions or comments, Chip would love to hear from you. You may contact him
by email atdahlkefinancial@sbcglobal.net |
