Trust Distributions, Part 2: Total Return Trusts
On Tuesday, I talked about the traditional way of structuring trust distributions (in terms of income and principal). Because of the tension this creates between income beneficiaries and remaindermen (and the resultant headaches for trustees), practitioners and others in the estate planning community proposed a new idea: the total return trust. Illinois' Trusts and Trustees Act now includes a provision for a total return trust (760 ILCS 5/5.3), including a procedure for converting a traditional "income and principal" trust into a total return trust.
How does a total return trust work? Essentially, income is deemed to be a percentage of the net fair market value of the trust's assets (for example, 4%). If a trust contains $1,000,000, then the income beneficiary would be entitled to $40,000 per year from the trust (regardless of whether the "income" of the trust for purposes of the Principal and Income Act is $4,000 or $100,000).
The major benefit of the total return trust is that the trustee is no longer conflicted about investments -- he or she has the clear task of investing trust assets in a way that maximizes the fair market value of the trust assets, since this maximization will benefit all beneficiaries.
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