Making Trust Payout Decisions
Stephen Trefts, President
As a trustee, our firm distributes millions of dollars a year to trust beneficiaries. Frequently, we are asked how we make the distribution decisions. The answer is simple: we rely upon the language in the trust document to guide us.
Therefore, it is important that the trust grantor understands the implications of the distribution provisions he or she writes into the document. This article addresses the nuances of several common distribution types.
A fixed allowance provides a beneficiary with the security of receiving a fixed sum of money at predetermined periods. It is especially appropriate for beneficiaries who are unable to handle a budget. However, there are some drawbacks with this type of distribution.
One drawback is that the amount of the allowance may be inappropriate in relation to the value of the trust or to the current cost of living, particularly if the trust was written many years before the trust was funded (as in a testamentary trust).
Another problem is that the purchasing power of a fixed allowance will dwindle over time. To remedy this problem, a grantor may want to provide for the allowance to increase according to a set formula, such as the consumer price index percentage, on an annual basis.
Lastly, the grantor should consider that a fixed allowance payout does not allow flexibility in the event of an emergency such as a medical crisis.
The major benefit of a net income payout is the preservation of trust principal; thereby ensuring that income will be available for the term of the trust and that there will be as- sets left for the remainder beneficiaries.
The challenge with this type of trust is that the trustee must balance investing to produce income for current beneficiaries with investing for trust growth to protect remainder beneficiaries. This may be to the detriment of beneficiaries who have high income needs.
As with a fixed allowance trust, the trustee has no flexibility to provide funds in the event of an emergency.
A unitrust provides for a fixed payment which is based on the fair market value of the trust at the beginning of each year. The payout may be made from income and principal. The benefit of this type of a payout is that it allows the trustee to invest for maximum return without regard for net income. Further, as the value of the trust grows, the income to the beneficiary increases. It also ensures that there will be assets for the remainder beneficiary.
This type of trust does not allow the trustee to make additional distributions in the event of an emergency.
MESH (Maintenance, Education, Support, and Health)
A MESH payout provision gives the trustee discretion to make distributions to or for the beneficiary for maintenance, education, support, and health. This language allows the trustee to look at needs in light of facts and circumstances that may have changed since the document was written and make a judicious decision regarding the beneficiary’s needs in those four areas only.
As with any type of discretionary trust, issues may arise with remainder beneficiaries who may feel that the trustee is improperly exercising discretion and spending their inheritance.
Frequently, the trustee is given absolute discretion to pay for anything the trustee deems appropriate for the beneficiary. This type of distribution language is frequently used when a beneficiary has severe problems such as drug or alcohol dependency, or mental disorders, or if the beneficiary is receiving Medicaid or other state or federal benefits for physical or mental incapacity.
The benefit for a grantor in creating this type of trust is the knowledge that the trustee has the flexibility to deal with the unpredictable future needs of the beneficiary. The entire trust may be used for the beneficiary’s benefit.
In a discretionary trust, it is always helpful for the trustee to know the original intent of the grantor and to have as much background information as possible on the beneficiary so he or she may balance current versus future needs.
In summary, a grantor must plan carefully with his or her attorney when creating trust payout language. Proper planning should include providing the future trustee with a draft of the trust so that he or she will have the opportunity to clarify the grantor’s intent and thoroughly understand the situation, needs, and potential conflicts that may arise in the future.
Proper planning will ensure that beneficiaries are cared for fairly and professionally and that the trust distributions conform to the grantor’s desires.
Print Date: Fall 2006