Consider Beneficiary Needs and the Trust’s Purpose - dummies

Consider Beneficiary Needs and the Trust’s Purpose

Beneficiaries’ needs change over time, and trust investments need to change in relation to them. As the trustee, you have to determine what the trust must do in order to meet those needs. You must keep the age of the beneficiary and the purpose of the trust in mind.

Beneficiary needs and trustee responsibilities

You need to judge when beneficiary payments are useful, and when they’re unnecessary. Even if the trust has a mandatory income beneficiary, you can still limit the distributions to that beneficiary by limiting the amount of income earned by the trust. Many trusts are invested primarily in non-income-bearing investments for that reason. You can also select high-income-bearing investments to benefit a beneficiary who needs the income from the trust to pay for expenses.

A young child who is a trust beneficiary likely needs little from the trust, especially if his or her parents are still alive and are able to provide life’s necessities. As that child begins college, he or she may look to the trust to pay for some or all higher educational expenses. Or a working adult may require little from the trust now, but those needs may increase after retirement.

Purpose of trust

Grantors often establish trusts for specific reasons, such as the following:

  • To pay for college.

  • To provide money for a first home purchase.

  • To provide a safety net for someone the grantor isn’t sure can completely provide for himself or herself.

You need to read the instrument very carefully to make certain that you know why the trust exists and then create a plan that answers that need.

Trusts that distribute income currently

Grantors often create trusts to provide steady income to beneficiaries. You have to make sure that the trust generates enough income every year. To keep pace with inflation, you must make sure the principal grows.

You may feel you need to make some principal distributions so a beneficiary can pay rent. Before you make a principal distribution, consider all your options. Reducing the amount of available principal won’t help increase the income for future years. However, depending on the terms of the trust instrument, you may have the discretion to do so, and sometimes principal distributions are appropriate.

Trusts that are age-based

Many trusts are created to behave one way while the beneficiary is one age and differently as that beneficiary ages. Make a calendar of when your beneficiary hits those ages.

An age-based trust is known as an accumulation trust during the early stages because it doesn’t make distributions while the beneficiary is young and therefore accumulates income. You want to invest a trust that’s accumulating income differently than one where the beneficiary depends on regular income distributions. An accumulation trust is typically invested in a way that minimizes the trust’s income tax hit. A trust might pay the top tax rate with just over $10,000 of ordinary income.

If your trust is still in the accumulation stage, investing in stocks that pay small dividends is a popular strategy because it limits the amount of taxable income while still allowing the value of the trust to grow. The trade-off you should expect from a stock that pays a small dividend is that the market price of that stock should grow substantially because the company is putting its profits back into the business rather than paying them out to shareholders. If you fail to see growth over time, don’t hesitate to sell the stock. It is better to realize that you’ve made a mistake and get out than to wait forever for the company to turn around.

As the beneficiary ages, and the trust begins to make distributions, you’re free to shift the investments to ones that produce as much income as you think it wise to give the beneficiary. After the beneficiary is receiving income from the trust, the tax liability for that income is paid by the beneficiary, not by the trust.

Spendthrift trusts

One of the most popular reasons a grantor creates a trust is because he or she doesn’t think that the beneficiary of that trust is able to handle large sums of money. A spendthrift trust is designed to deal with that situation, giving absolute control of the money to the trustee, who then must make the decisions about how much money to distribute and how often.

Spendthrift trusts are absolutely discretionary. The trustee has total control over the distributions. The only requirement is that the best interest of the beneficiary must be your top priority. You may distribute income or principal if in your best judgment it benefits the beneficiary, even if the payments aren’t made directly to the beneficiary. If your beneficiary has medical issues that require care, you may opt to pay the beneficiary’s medical bills directly instead of giving the money to the beneficiary to do so.