As a trustee, you must know when to make payments from the principal of the trust and when to make payments from the income of the trust. For your trustee fees, create an equitable formula so that a percentage of your fee comes from the trust principal and the other percentage of your fee is from the trust income.
The trust principal is the property that the trust owns. Although trust principal starts with the assets that originally fund the trust, it may increase or decrease. For example, trust principal may increase or decrease if the sale of trust property creates capital gains or losses. Trust principal may increase if the grantor makes additional contributions to the trust.
Most assets that the principal of the trust earns are income. Trust income includes stock dividends, interest earned on bank accounts or bonds, rents from real estate owned by the trust, and earnings received from a business the trust owns.
Money may always seem like money to you, but within a trust, it belongs to either principal or income. And, although making a distinction between the two may seem silly when paying trust bills, you really must.
Because different people may be entitled to receive money and property from either income or principal, making payments (whether expenses or distributions) from the correct side of the account is crucial.
More than one trustee has been sued because they paid all trustee fees from principal (or income), for example.
Remember, when you make all payments from one side, you favor the eventual owners of the property from the other side (because their share will grow faster). To avoid any hint of favoritism, allocate fees and expenses against the type of income that generated that cost.
When you’re not sure (like with your trustee’s fee), create an equitable formula so that a certain portion of your fee is always paid from principal, and the rest from income.