It is typical for trusts to provide that income is to be paid to a beneficiary automatically, but principal is to be distributed only for certain specified purposes (such as health, education, support and maintenance of the beneficiary). In times of modest investment returns where a 2% interest rate or dividend is considered to be a good return, by the time expenses are subtracted, an income beneficiary may not receive very much at all from the trust. A tension can develop between the current income beneficiary, who will want the trust assets to be invested in income-producing assets (like bonds), even at the expense of appreciation, and the remainder beneficiaries, who want the trust assets invested in appreciating assets, such as stocks.
Some of the investment dilemma can be alleviated with a “total return trust.” This type of trust provides that a stated percentage of the trust assets will be paid to the current beneficiary, regardless of whether the distribution is considered income, principal or capital gain. The Alabama Legislature recently amended the Alabama Principal and Income Act to provide for two types of total return trusts (called “unitrusts”).
One type of unitrust can be established as a total return trust from the beginning, with the trustee being directed to pay a stated percentage (typically between 3%-5%) of the trust assets, revalued each year, to the beneficiary. This trust would allow the trustee the freedom to invest for the best interest of both types of beneficiaries while still ensuring that the income beneficiary receives at least a certain amount from the trust. The trustee would usually also be authorized to make additional distributions if the current beneficiary needed funds over and above the stated percentage payout.
The second type of unitrust authorized under the new law is a traditional trust which can be converted into a total return trust by the beneficiaries, the trustees or the court. The statute provides several helpful methods of accomplishing this result, some of which do not require court approval. If you are a beneficiary of an existing trust or if you have established a trust benefitting family members and you believe that it would be advantageous to the beneficiaries for the trust to be converted to a unitrust, you should contact your estate planning attorney for additional information and details.