A unitrust is a useful tool, but like any other trust, it has to be the right tool for the situation. If a trust is converted to a unitrust, there are a number of interesting advantages. Here’s a classic scenario that illustrates the value of a unitrust.
It is the second marriage for one or both spouses. There are children from a first marriage. The first spouse to die leaves their estate in trust for the surviving spouse during their lifetime. Upon death, the trust property goes to the children from their first marriage.
All too often, the children of the first marriage resent having to wait to receive their inheritance. Since the surviving spouse is interested in maximizing income, there is little chance for capital growth in the trust. Under the current Prudent Investor rules, a trustee owes a duty to both the income beneficiary and the remainderman. Normally, this means investing 50% of the trust assets for income and 50% of the trust assets for growth.
Assume the trust principal is $1 million and has 50% of its assets invested in income-producing assets yielding 3% per year; the balance of the assets are invested for growth. The gross income of the trust is $15,000. After trust expenses, the surviving spouse would receive $10,000 for an effective rate of return of 1%; and that’s before the surviving spouse pays income tax.
Meanwhile, only 50% of the trust assets are invested for growth. This ultimately decreases the amount the children from the first marriage can expect to inherit.
New York law permits the trust to be converted to a unitrust. A unitrust is a trust that pays the income beneficiary a set percent of the trust assets each year, allowing the investment of the entire trust principal for growth. In New York, the default unitrust rate is 4% of the value of the assets on the last day of each year. New York is the only state whose unitrust conversion law provides the party requesting the unitrust conversion is presumed to be correct.
If a unitrust were adopted in the above scenario, the surviving spouse would receive $40,000 each year.
With proper investment management of the trust assets, one can expect appreciation between 6 to 10% per year over the long-haul. The surviving spouse receives more money each year, while the trust assets appreciate at a rate higher than if invested under the Prudent Investor Rule. The unitrust offers a win-win strategy and avoids friction between the surviving spouse and children from prior marriages.
The larger lesson for individuals, families, CPAs and even fellow estate planning attorneys: there are many new opportunities, particularly if trusts have not been reviewed in several years, and there is no such thing as a one-size-fits-all trust.