It’s Time to Review Your Trust! - Rodgers & Associates
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It’s Time to Review Your Trust!

It’s Time to Review Your Trust!

I met recently with a widow to review her finances and offer recom­men­da­tions on how she could improve her situation. The current low interest rate environment has caused problems for many retirees and this widow’s situation was similar. Her main financial goal was to increase her income.

A large portion of her income was coming from a trust estab­lished when her husband died more than 10 years ago. This was a typical credit shelter trust paying income to the surviving spouse during their lifetime. All principal will be distributed to the children after the second spouse dies. The husband named a local bank as irrev­o­cable trustee. The trust worked well in the beginning when interest rates were higher. Now that interest rates have fallen to 40 year lows and her expenses have steadily increased due to inflation, the trust was not producing enough income.

The bank trustee refused to make changes to the investment allocation in favor of producing more income. This is a common problem existing because the trustee has a conflict between serving the income interests of the survivor and growth interests of the benefi­ciaries. Most corporate trustees have a maximum allocation to income or growth invest­ments. Once that maximum is reached there is little they are willing to do to alter the portfolio.

Many trusts were written years ago when the estate-tax exemption was under $1 million. Older trusts were written with less flexi­bility than the ones written in recent years. Some trusts may be based on outdated tax laws, and others may reflect an era when wives had little experience with, or exposure to, financial matters. Those who have trust provi­sions in their wills should review them to see if they still meet their needs. Trusts drafted today may make it easier to generate income for the surviving spouse by giving the trustee the ability to convert the trust to a private unitrust. This provision allows a trust to invest for total return and distribute a fixed percentage of the value (3–5% for example) to the income benefi­ciary. Another common provision allows the trustee to make equitable adjust­ments between principal and income. The trustee allocates some principal to income and distributes it to the surviving spouse, the income benefi­ciary. Most states allow both conver­sions to private unitrusts and equitable adjust­ments.

Including these provi­sions will help avoid bad situa­tions in the future. Those with existing trust problems are in a difficult situation. Gaining access to the trust principal may depend on the cooper­ation of the trustee and the other benefi­ciaries. The children will be agreeing to reduce their future inher­i­tance. Even if all the trust benefi­ciaries come to an under­standing, the trustee may also have to be persuaded. Most corporate trustees are reluctant to do anything besides what’s in the trust. However, with the cooper­ation of the trustee and benefi­ciaries a nonju­dicial settlement may be possible. The trustee and the benefi­ciaries can agree to modify the trust or to give the trustee a desirable power that’s not in the original trust agreement. Such powers can allow the trustee to add the provi­sions mentioned earlier to address a surviving spouse’s income needs. This agreement can be for any purpose, except that it cannot modify a material purpose of the trust.

This solution was not possible in the case of the widow I met with. Some of the benefi­ciaries were children from another marriage who wouldn’t agree with changing the trust. Her income needs would have to be addressed in other ways.

The best time to change a trust is before it becomes irrev­o­cable. Review your trust provi­sions on a regular basis (every 3–5 years is recom­mended) or anytime there is a major change in estate law. The current estate law is scheduled to change January 1, 2013. It may be a contin­u­ation of the rules currently in place or something entirely new. That doesn’t mean you should wait until next year to review trust provi­sions. Older trusts should be updated to give your heirs the flexi­bility they may need to avoid coming up short in years to come.

Rick’s Insights

  • Newer trust provi­sions allow a trust to convert to a unitrust which may increase income to a surviving spouse.
  • Older trusts may be modified if all benefi­ciaries are in agreement and the trustee cooperates.
  • Don’t wait to see if the estate law changes if you have older trusts that need to be updated with newer more flexible language.