Trust Distributions, Part 1: Income and Principal
Most ongoing trusts contain language that allows beneficiaries to obtain money from the trust based on certain criteria. Historically, trust property (and a beneficiary's right to it) has been described in terms of income and principal. For instance, a beneficiary might have the right to all income from the trust; upon this beneficiary's death, a remainder beneficiary may receive the entire principal of the trust.
Because of the above, it's important to understand what is meant when we talk about income and principal. The Illinois Principal and Income Act (755 ILCS 15/1 et seq.) (the "Act") defines these terms as follows:
Principal is the property which has been set aside by the owner or the person legally empowered so that it is held in trust eventually to be delivered to a remainderman, while the income is in the meantime taken or received by or held for accumulation for an income beneficiary.
Income is the return in money or property derived from the use of principal....
The Act goes on to explain which types of property constitute income and which constitute principal. For instance, stock dividends are considered principal, while cash dividends and interest received are considered income. The trustee is also obligated to distinguish between income and principal in the handling of trust expenses (some expenses are allocated to income, and some to principal).
As you may have guessed, there can be a fair amount of tension between a trust beneficiary with a current right to income and a remainder beneficiary. The former wants to maximize trust income while the latter wants to grow the principal of the trust. This tension became greater in the 1990's, with the run-up in tech stocks -- many of these stocks paid no cash dividends, but were experiencing huge jumps in share price. As a result, tech stocks were hated by income beneficiaries and loved by remainder beneficiaries. The opposite was true of bonds, which didn't appreciate much but which produced a fair amount of income.
Tomorrow I'll talk about a potential solution to the income beneficiary vs. remainder beneficiary fight.
