Preserve Your Happy Family With a Total Return Unitrust

When the interests of trust beneficiaries — for example, a widowed spouse and the children of the deceased — come into conflict, everyone in the family can suffer. "Lifetime" beneficiaries generally want a trust to invest in income-producing securities, while "remainder" beneficiaries typically prefer growth investments, such as stocks. However, it's possible to align the interests of both groups with a total return unitrust (TRU). With a TRU in place, your trustee doesn't have to act as a referee and can concentrate on developing the most effective investment strategy. 

Compromise to Satisfy Everyone 

When a trust is designed to provide benefits for two classes of beneficiaries, often in different generations, it presents a difficult challenge for the trustee. For example, let's say Meredith's will establishes a trust that pays all its income to her husband, Jon, for life. It then divides the trust assets equally among her three children from her first marriage (the "remainder beneficiaries"). The trust names Meredith's friend, Sandy, as trustee. Jonathan outlives Meredith by 10 years. 

Sandy has a fiduciary duty to act in the best interests of all the beneficiaries, but traditional trust design makes it difficult for her to be impartial. Suppose Meredith leaves $2 million to the trust. To provide Jon with a steady income stream, Sandy places the trust assets in fixed-income investments that generate a 5% return. Jon receives income of $100,000 per year, and when he dies the trust's principal — still $2 million — is distributed to Meredith's children. Not a bad inheritance, but its value has been eroded by 10 years of inflation. 

Suppose, instead, that Sandy invests the trust assets in growth stocks that earn a 9% annual return. Ten years later, the trust's value has appreciated to more than $4.7 million. That's good news for Meredith's children, but this approach likely generates little or no income for Jon. 

To make everyone happy, Sandy compromises. She invests half of the assets in growth stocks and the other half in fixed-income vehicles. The $1 million in fixed-income investments generates $50,000 per year for Jon, and at the end of the trust term the principal is still $1 million. The other $1 million, however, has grown to nearly $2.4 million. Thus, the total amount in the trust is almost $3.4 million. 

Broader Investment Opportunities 

The advantage of a TRU is that it frees the trustee to employ investment strategies that maximize growth (total return) for the remainder beneficiaries without depriving lifetime beneficiaries of income. Rather than pay out its income to the lifetime beneficiary, a TRU pays out a fixed percentage (typically between 3% and 5%) of the trust's value, recalculated annually, regardless of the trust's earnings. 

Going back to our previous example, suppose Meredith's trust is designed as a TRU that makes an annual payout to Jon equal to 3.5% of the trust's value, recalculated annually. Sandy, relieved of the duty to generate income for Jon, invests the trust assets in a diversified portfolio of growth stocks that yield a 9% annual return. Jon's payments from the trust start at $70,000 and grow steadily over the trust's term, reaching more than $113,000 by the tenth year. 

At the same time, the value of the trust principal grows to more than $3.4 million, which is distributed to Meredith's children when Jon dies. Thus, the lifetime beneficiary and the remainder beneficiaries are better off with a TRU than they would have been under the compromise approach described earlier. 

Laws and Best Practices 

If you're considering implementing a TRU, you'll need to move forward carefully. Ask your financial advisor to project the benefits your beneficiaries will enjoy under various scenarios, including different:

• Payout rates,
• Investment strategies, and
• Market conditions. 

Keep in mind that for a TRU to be effective it must produce returns that outperform the payout rate, so don't set the rate too high. 

Be sure to investigate your state's trust laws, because some states disallow TRUs. Also, many states establish payout rates (or ranges of permissible rates) for TRUs, so your flexibility in designing a TRU may be limited. Finally, if a trust is required to pay out all its income to a current beneficiary, be sure that unitrust payouts will satisfy the definition of "income" under applicable state and federal law. 

Keep the Peace

Disputes over the distribution of estate assets can occur even in families that typically get along. Help preserve the peace by making a TRU part of your estate plan. Your trustee will probably thank you.