I’m glad you’ve made it through A Matter of Trusts – Part 1 and A Matter of Trusts – Part 2. Once again I must tell you who my inspiration was for this post. OK I’ll be honest time, it was Bill Joel’s song “A Matter of Trust” all along.
I feel much better after admitting that. But I digress let’s talk about beneficiaries.
The beneficiary is the person (or persons) who holds the beneficial title to the trust assets. While the beneficiary’s name does not appear on the deed to the trust assets, the trustee must manage the assets in the best interests of the beneficiary.
A trust may have more than one type of beneficiary. Since most trusts are designed to terminate at some point in the future, the two most common types of beneficiaries are income and remainder beneficiaries.
The income beneficiary is the person or entity who has the right to current income or distributions from the trust or the current right to use the trust assets. When distributions are made during the term of the trust, the income beneficiary is generally the person who receives those distributions The remainder beneficiary is the individual or entity who is entitled to receive the assets that remain in the trust on the date of its termination.
Sometimes, the income and the remainder beneficiaries of a trust are the same person.
Sometimes, the income and the remainder beneficiaries of the trust are different persons.
Sometimes, a trust will have only income beneficiaries and not remainder beneficiaries. (Dynasty Trust)
Traditionally, income beneficiaries are entitled to receive all the income from the trust and the remainder beneficiaries are entitled to receive the principal of the trust. Each state defines income and principal for trusts established in that state, but generally the term “income” includes dividends and interest earned on trust investment, and “principal” includes the original trust principal plus all capital gains.
Capital gains, or gains derived from appreciation in the value of trust property, are considered corpus of the trust and are retained in the trust for the benefit of the remainder beneficiaries. But, in most states, left out instructions contained in the trust document to the contrary, the income beneficiary will receive income and dividends and the trust will retain the the capital gains for the benefit of the remaindermen.
When long-term trusts (such as dynasty trusts) are created, the income beneficiaries are not always permitted to receive a distribution of the trust income. It is more common for long-term trusts to give the trustee discretion as to the timing and amount of income distributions, and to include specific language in the trust instrument authorizing the trustee to purchase assets for the use of the beneficiaries of the trust. Allowing beneficiaries to use trust assets, instead of requiring distributions from the trust, often results in better estate planning from a multi-generational perspective.
At his death, YFS created a dynasty trust for the benefit of his family. The trust requires the trustee to distribute the income to his children, and when each child dies, to split up that child’s share and distribute the income to the child’s children. All of YFS’s children are independently wealthy and are renowned art collectors. When they receive the income distributions from the trust, they use the money to purchase art that is displayed in their homes and offices. When each of the children die, the fair market value of the art they purchased will be included in their gross estates, and will be subjected to estate tax. Assume the same facts as above, except that YFS’s trust did not mandate the distribution of income to the children. Instead, the trustee used the income of the trust to purchase artwork that is displayed in the homes and offices of the children. When the children die, the fair market value of the art work will not be included in their gross estates and will not be subject to estate tax, since the children did not own the artwork, and therefore have nothing to transfer through their estate at death. YFS’s grandchildren can now enjoy the art owned by the trust and exclude the value of the art from their gross estates as well. In such a case, the income earned by the trust is subject to income tax at the trust level.
As the above examples demonstrate, the ability to separate the ownership of assets (vested in the trustee) from the use of assets (vested in the trust beneficiaries) can, over time, save a significant amount of money for the family by avoiding the transfer tax over multiple generations.
Trust beneficiaries do not have to own assets outright; it is better to give them the right to use trust assets as if they owned them.