BLAZING TRAILS AROUND PEAKS AND VALLEYS TOTAL RETURN TRUSTS

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BLAZING TRAILS AROUND PEAKS AND VALLEYS TOTAL
RETURN TRUSTS

• OR
• Getting income and remainder beneficiaries
• on the same team

C. Fred Daniels Leonard Wertheimer III
CABANISS JOHNSTON
www.cabaniss.com
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ALL INCOME TRUSTS

• All income to the income
  beneficiary for
  his or her life.
• Income dividends and interest
• Income not appreciation in value capital gains.
• If the trust allows the trustee to invade
  principal for health, support and maintenance,
  how does the Trustee document the need?

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POP QUIZ QUESTION 1

• All income trust
• Trustee invests 100 of trust in Growth Fund of
  America, which appreciated 9.2 in 2013 and had
  an income yield of .7
• Trustees fee 1.25
• Which beneficiaries are happy
• Income beneficiaries
• Remainder beneficiaries

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POP QUIZ QUESTION 2

• Same as Question 1, except Trustee invests 100
  of trust in PIMCO Institutional Fund, which
  appreciated 1.4 in 2013 and had an income yield
  of 5.4
• Which beneficiaries are happy
• Income beneficiaries
• Remainder beneficiaries

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SETTLOR EXPECTATIONS

• 1,000,000 trust for daughter
• Income of 40-60,000 per year

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HISTORICAL 10-YEAR TREASURY RATES
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HISTORICAL S P 500 DIVIDEND YIELDS
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MISSION IMPOSSIBLE Meeting current portfolio
needs of incomebeneficiaries without sacrificing
long-term return potential for remainder
beneficiaries

• An income trust invested 60 in stocks and 40 in
  bonds would have produced the following income
  for income beneficiaries in each of the following
  years
• 1982 1992 2002 2012
• Yield 8.8 4.7 2.9 1.7
• All beneficiaries are likely to be disappointed.

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INVESTMENT STRATEGY THE UNIFORM PRUDENT
INVESTOR ACT

• Enacted in 2006
• Each asset judged as it relates to the portfolio
  as a whole.
• Return is total return, including income and
  appreciation.
• Diversification required, barring special
  circumstances.
• QUERY Is it possible to invest for a total
  return in an all income trust?

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DISTRIBUTION POLICY THE UNIFORM PRINCIPAL AND
INCOME ACT

• Enacted in 2000 and amended in 2013
• Section 104 - an equitable adjustment provision
  allowing the trustee to re-characterize income
  and principal if necessary to treat all
  beneficiaries fairly and if the terms of the
  trust expressly refer to section 104.
• Rarely included in trust documents
• Trustees usually uncomfortable exercising

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2013 REVISION TO UNIFORM PRINCIPAL AND INCOME ACT

• Authorizes total return trusts
• Payment of a fixed percentage of the net value of
  the trust to the beneficiary having a present
  interest.
• Maximization of return benefits
• ALL BENEFICIARIES!!!

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TYPES OF UNITRUSTS

• Express. Code of Alabama (1975) 19-3A-105.
• Converted. Code of Alabama (1975) 19-3A-106.

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TOTAL RETURN TRUSTS

• With a reasonably steady return slightly
• exceeding payout, growth in principal should
• compensate for inflation.
• Beginning 6
  4 Ending
• of Year Balance Return
  Payout Balance
• 1 100,000.00
  6,000.00 (4,000.00) 102,000.00
• 2 102,000.00
  6,120.00 (4,080.00) 104,040.00
• 3 104,040.00
  6,242.40 (4,161.60) 106,120.80
• 4 106,120.80
  6,367.25 (4,244.83) 108,243.22
• 5 108,243.22
  6,494.59 (4,329.73) 110,408.08
• 6 110,408.08
  6,624.48 (4,416.32) 112,616.24
• 7 112,616.24
  6,756.97 (4,504.65) 114,868.57
• 8 114,868.57
  6,892.11 (4,594.74) 117,165.94

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THE UNITRUST AMOUNT

• Income and net income redefined to be a
  unitrust amount.
• Normal income expenses not deductible from
  unitrust amount.
• Typically 3-5 of the net fair market value of
  trust assets.
• No power to adjust between income and principal.
• Complicated rules for determining unitrust
  amounts when deferred compensation and annuities
  are involved.

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VALUATION DATES

• Can be first or last day of year.
• Last business day of year may be better choice.
• Best choice is that the trustee determines the
  appropriate valuation date or dates.

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THE SMOOTHING EFFECT

• The effects of peaks and valleys
  are minimized by
  using a moving
  value of trust assets instead of
  current year
  value.

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ILLIQUID AND HARD TO VALUE ASSETS

• Consider valuation approach for closely held
  business interests, real estate, mineral
  interests, artwork and other assets without
  published market values.
• Authorize use of reasonable estimates.
•  

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PERSONAL USE ASSETS
Personal use assets can be excluded from the
calculation of the value of the assets.  
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PRINCIPAL INVASIONS
The trustee can be authorized to invade
principal if the unitrust amount is insufficient
for the beneficiarys needs.    
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ADDITIONS TO AND DISTRIBUTIONS FROM PRINCIPAL

• Additions to the trust or principal distributions
  from the trust may occur during the year.
• Trustee discretion in calculating
• effect on unitrust amount

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SUBCHAPTER S STOCK

• Unitrust Amount definition of income likely
  undesirable if S stock is held in a Qualified
  Subchapter S Trust.
• Better to direct that income from such S stock be
  determined using traditional concepts of
  principal and income.

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TOTAL RETURN TRUST QUALIFIEDFOR MARITAL DEDUCTION

• Treasury Regulation respects allocations between
  income and principal if local law provides for a
  reasonable apportionment of total return.
• A unitrust amount between 3 and 5 of the value
  of the trust assets, is recognized as reasonable.
• Satisfies the all income requirement of
  marital deduction
  trusts.

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UNITRUST AMOUNTS EXCEEDING 5

• Allocated to principal.
• High percentage may deplete the trust over time.

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EXPRESS UNITRUST DEFAULT PROVISIONS

• The frequency of payment of the unitrust amount
  during the year
• Any adjustments to be made to the unitrust amount
  due to other payments from or contributions to
  the trust
• The valuation dates to use
• How nonliquid or hard to value assets shall be
  valued, how frequently to value them and whether
  to estimate their value 
• Whether to omit from the calculations the value
  of trust property occupied, used or possessed by
  a beneficiary and 
• Any other matters necessary for the proper
  functioning of the unitrust that are not
  inconsistent with the governing instrument.

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CONVERSION OF EXISTING TRUSTS

• The effect - substitute the unitrust amount
  for for the terms
  "income" and net income in the
  governing instrument. Other
  provisions concerning distributions
  remain unchanged.
• Discretionary distributions subject to a standard
  such as health, education, maintenance and
  support
• Distributions upon the attainment of a designated
  age continue to apply.
• Sprinkle powers among beneficiaries.
• Withdrawal powers granted by the trust.

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CONVERSIONBY TRUSTEE

• A trustee may convert a trust into a unitrust
  if
• Conversion will enable the trustee to better
  carry out the
  purposes of the trust.
• The trustee gives written notice and an
  explanation to all qualified beneficiaries.
• There is at least one sui juris income
  beneficiary and one sui juris remainder
  beneficiary.
• No beneficiary objects within 60 days of mailing
  the notice.

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CONVERSION BY QUALIFIED BENEFICIARIES

• Written instrument delivered to the trustee and
  setting forth the following
• The conversion will enable the trustee to better
  carry out the purposes of the trust.
• The same notice information is required in a
  conversion by trustee.
• The trustee is authorized to seek court
  confirmation that the
  conversion is
  appropriate.

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CONVERSION BY COURT

• Trustee or qualified beneficiary may petition the
  court to review the conversion if
• A beneficiary timely objects.
• There are no sui juris income or presumptive
  remainder beneficiaries.
• The trustee does not consent.

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MODIFICATION OF CONVERTED UNITRUST
May include reverting from a unitrust to the
prior trust provisions.
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INCOME TAX ILLUSTRATIONS(Simple Trusts)

• 4 Unitrust
• No amounts distributable in excess of Unitrust
  Amount
• 1,000,000 net asset value