Trusts Flashcards
ISSUE: Could the trustee have properly distributed trust assets to the son to enable him to pay his hospital bill, child support obligations, or loan to purchase the computer-gaming system? ANSWER: The settlor created a discretionary support trust subject to a spendthrift clause. The hospital bill and child support debt are support expenses for which the trustee could distribute trust assets to the son. The loan to purchase a computer-gaming system is not likely to be characterized as support.
The settlor created a discretionary support trust subject to a spendthrift clause. A support trust permits distributions from the trust to enable the beneficiary to maintain his or her accustomed standard of living. When a trust instrument grants the trustee of a support trust discretion whether or not to pay a beneficiary’s support-related expenses, the trustee’s judgment controls unless the trustee abuses his discretion.
This trust is also subject to a spendthrift clause. This clause may prevent a beneficiary’s creditors from reaching trust assets, but it does not prevent the beneficiary himself from reaching trust assets if the trustee has abused his discretion in failing to make payments to the beneficiary.
The meaning of the term “support” is fact-dependent. Support includes more than necessities or bare essentials. Most courts measure support in terms of the lifestyle to which the beneficiary has become accustomed even if the trust instrument does not expressly refer to that lifestyle. A beneficiary’s accustomed lifestyle is determined at the time the beneficiary’s trust interest is created, but is subject to adjustment to accommodate the beneficiary’s changing needs.
Necessary medical care is invariably treated as support. Support also invariably includes reasonable amounts for the support of minor children who reside elsewhere but for whom the beneficiary either chooses or is required to provide support.
Here, the trustee could properly have distributed trust assets to the son to pay the son’s hospital bill and child support obligation.
On the other hand, without more facts, a distribution to allow repayment of the son’s debt incurred for the purchase of a computer-gaming system would not appear to be a distribution for the son’s support. Of course, if the son could establish that such a system is necessary to allow him to live in accordance with his accustomed lifestyle, then it might be considered a support expense. However, the facts state that the son’s income is about $35,000, a modest sum in light of the son’s child support obligation and expenses for basic needs such as health care, food, clothing, shelter, and transportation. Given this income, it is unlikely that the son could establish a lifestyle that would warrant the trustee’s conclusion that the recreational computer-gaming system is a support expense.
ISSUE: Did the trustee abuse his discretion in refusing to make any distributions to the son? ANSWER: Yes. The trustee likely abused his discretion in failing to make any distributions to the son, including distributions for the payment of the hospital bill and child support.
The fact that the son’s hospital bill and child support obligations should be characterized as support is not the end of the matter. When the trust instrument grants a trustee discretion to pay a beneficiary’s support-related expenses, the trustee’s judgment controls unless the trustee abuses his discretion. A trustee’s discretionary power is subject to judicial control only to prevent abuse of the discretion by the trustee. Trustees may have a number of legitimate reasons to withhold payments from a beneficiary, including discharging the trustee’s duty to act impartially with respect to all trust beneficiaries and the beneficiary’s ability to pay the expenses from other resources. However, if a court finds that a trustee acted in bad faith or with an improper motive, it may overrule his decisions.
What constitutes an abuse of discretion, according to the Restatement (Third), depends upon the terms of the trust instrument and the other duties of the trustee, such as the duty to administer the trust in accordance with its terms, the duty to act impartially, and the duty of care. These duties, read together, entitle the beneficiary to general information concerning the bases upon which the trustee’s discretionary judgments have been or will be made. Furthermore, a trustee abuses discretion by acting in bad faith or with an improper motive.
As section 50 of the Restatement (Third) suggests, where, as here, there are multiple trust beneficiaries, the trustee’s duty of impartiality requires that, in making distributions, the trustee act with due regard for the diverse beneficial interests created by the terms of the trust. The duty of impartiality is an extension of the duty of loyalty to beneficiaries but involves, in typical trust situations, unavoidably and thus permissibly conflicting duties to various beneficiaries with their competing economic interests.
It would be overly simplistic, and therefore misleading, to equate impartiality with some concept of ‘equality’ of treatment or concern—that is, to assume that the interests of all beneficiaries have the same priority and are entitled to the same weight in the trustee’s balancing of those interests. Impartiality does mean that a trustee’s treatment of beneficiaries or conduct in administering a trust is not to be influenced by the trustee’s personal favoritism or animosity toward individual beneficiaries, even if the latter results from antagonism that sometimes arises in the course of administration.
Here, there is a strong argument that the trustee abused his discretion by withholding support distributions from the son. He ignored the son’s repeated requests for distributions, without offering any reason for his refusals. He made substantial distributions to the daughter, whose income was not, on average, different from the son’s. The trustee made disparaging comments about the son (that the son was a “bum,” a “terrible father,” and an “adulterer,” and was “rude” to the trustee). Together, these facts support an inference that the trustee withheld distributions from the son because of personal animus rather than a valid reason. All of this supports the conclusion that the trustee abused his discretion in withholding distributions from the son.
[NOTE: Although the question does not ask whether the son could successfully sue based on the trustee’s abuse of discretion or what he could recover if his suit were successful, in cases like this one, if the court finds an abuse of discretion, it will typically make an independent judgment of what the trustee would have distributed when carrying out his fiduciary duties and then direct that such payment be made from the trust, if trust assets are available, or otherwise surcharge the trustee.]
ISSUE: In light of both the discretion granted the trustee and the spendthrift clause in the trust, may the son’s three creditors obtain orders requiring the trustee to pay their claims against the son from trust assets? ANSWER: Despite the trust’s spendthrift clause, the son’s former wife and, assuming that the necessaries doctrine applies, the hospital may reach the son’s interest in the trust to satisfy their claims if the trustee abused his discretion. However, the friend cannot reach the son’s interest to satisfy his claim against the son.
The trust created by the settlor was discretionary. If the terms of a trust provide for a beneficiary to receive distributions in the trustee’s discretion, a creditor of the beneficiary is entitled to receive any distributions the trustee is required to make in the exercise of that discretion.
This general principle does not apply, however, when a trust includes a spendthrift clause. A spendthrift clause puts trust assets out of the reach of most creditors of a trust beneficiary until such time as trust assets are distributed to that beneficiary.
However, even when a trust provides spendthrift protection, claims against a beneficiary for unpaid child support may still be enforced against the trust. A court may order the trustee to pay the child such amount as is equitable under the circumstances but not more than the amount the trustee would have been required to distribute for the benefit of the beneficiary had the trustee complied with the support standard or not abused the discretion. Here there is a strong argument that the trustee breached his discretion, such that the former wife will be able to obtain payment from the trustee.
In some jurisdictions, creditors who provided the beneficiary with “necessaries” such as health care may reach the beneficiary’s interest in satisfaction of any unpaid debt despite a spendthrift clause. Comments to the Restatement (Third) of Trusts suggest that the creditor may reach the beneficiary’s interest but may not force a sale of the interest. In such a case, the court could direct the trustee to distribute trust income to the creditor until the claim is paid. Medical care is invariably treated as a necessary. But if in addition to a spendthrift clause, distributions are discretionary with the trustee, the creditor who provided the beneficiary with a necessary cannot compel a distribution if the beneficiary could not do so. In other words, the creditor cannot compel a distribution in the absence of an abuse of discretion.
The necessaries exception is not recognized in the Uniform Trust Code. Comments to the Restatement also suggest that the necessaries rule, while consistent with prior trust Restatements, is not followed in some U.S. jurisdictions. In these jurisdictions, the hospital cannot reach the son’s interest in the trust in satisfaction of its claim.
In jurisdictions that follow the necessaries doctrine as applied to a spendthrift clause, the hospital’s claim is not barred by the spendthrift clause. But because distributions from the trust are discretionary, the hospital will not be able to reach the son’s interest unless the trustee abused his discretion. Here, there is a strong argument that the trustee abused his discretion, thus allowing the hospital to reach the son’s interest and obtain some payment from the trustee.
The friend should not succeed in his suit against the trustee. The friend’s claim is not a claim for support, and here, the facts cannot support an assertion that a $5,000 computer-gaming system is a “necessary” for the son.
ISSUE: Did the trustee breach the duty of loyalty by renting a trust-owned apartment to himself at a market rate? ANSWER: Yes. The trustee breached his duty of loyalty when he rented a trust-owned apartment to himself even though he paid a market rate.
A trustee owes trust beneficiaries a duty of loyalty. This duty arises under the common law and by statute. Under the common law, a trustee is prohibited from making transactions that place the interest of the trustee or another above the interest of trust beneficiaries. The duty of loyalty prohibits two types of transactions: self-dealing, where the trustee deals with trust property for the trustee’s personal benefit, and conflict of interest, where the trustee acts on “behalf of others to whom the trustee also owes obligations.” Here, the trustee’s lease of a trust-owned apartment to himself was self-dealing. The lease thus breached the trustee’s duty of loyalty.
Because of the so-called “no-further-inquiry” rule, the fact that the trustee paid a market rate is irrelevant to the conclusion that the trustee engaged in self-dealing. The trustee is strictly prohibited from engaging in transactions that involve self-dealing or that otherwise involve or create a conflict between the trustee’s fiduciary duties and personal interests. As noted in the Restatement (Third), under the no-further-inquiry rule, “it is immaterial that the trustee may be able to show that the action in question was taken in good faith, that the terms of the transaction were fair, and that no profit resulted to the trustee.” This strict approach is justified on the grounds that “it may be difficult for a trustee to resist temptation when personal interests conflict with fiduciary duty. In such situations, for reasons peculiar to typical trust relationships, the policy of the trust law is to prefer (as a matter of default law) to remove altogether the occasions of temptation rather than to monitor fiduciary behavior and attempt to uncover and punish abuses when a trustee has actually succumbed to temptation. This policy of strict prohibition also provides a reasonable circumstantial assurance (except as waived by the settlor or an affected beneficiary) that beneficiaries will not be deprived of a trustee’s disinterested and objective judgment.”
The Uniform Trust Code takes a similar approach. It adopts the no-further-inquiry rule and provides that a self-dealing transaction is voidable by trust beneficiaries. As noted in the comments, “transactions involving trust property entered into by a trustee for the trustee’s own personal account are voidable without further proof. It is immaterial whether the trustee acts in good faith or pays a fair consideration.”
ISSUE: Did the trustee breach the duty of prudent administration (a/k/a duty of care) by failing to purchase fire/casualty insurance on trust property, resulting in a $50,000 uninsured loss? ANSWER: Yes. The trustee breached his duty of prudent administration (a/k/a duty of care) when he failed to purchase fire/casualty insurance on the real property
Both the Restatement of Trusts and the Uniform Trust Code impose on trustees a “duty of prudent administration.” Under the Restatement, the trustee has a duty to administer the trust as a prudent person would, in light of the purposes, terms, and other circumstances of the trust. Under the UTC, a trustee shall administer the trust as a prudent person would, by considering the purposes, terms, distributional requirements and other circumstances of the trust. Both authorities agree that, to satisfy the duty of prudent administration, a trustee must “exercise reasonable care, skill, and caution.”
The Uniform Trust Code further provides that a “trustee shall take reasonable steps to take control of and protect the trust property.” This section is based upon the Second Restatement of Trusts § 176. A comment to § 176 of the Restatement specifies that a trustee’s failure to purchase fire/casualty insurance for trust property when such “insurance is customarily taken by a prudent” person is a breach of the duty to protect (a subset of the duty of care/prudent administration).
Here, the trustee failed to purchase a fire/casualty policy on the trust’s rental property, resulting in a loss to the trust. This is a breach of trust because a prudent person would have purchased such a policy on the property.
[NOTE: An accurate analysis of the legal standards is more important than the examinee’s conclusion regarding whether the purchase of insurance would have been prudent.]
ISSUE: Did the trustee breach the duty to administer in accordance with applicable law by allocating the entire $50,000 expense occasioned by the unexpected roof repair to trust income? ANSWER: Yes. The trustee breached his duty to administer the trust in accordance with applicable law by allocating the $50,000 repair expense exclusively to income.
A trustee has a duty to administer the trust “diligently and in good faith, in accordance with the terms of the trust and applicable law.” Because of the trustee’s obligation to comply with applicable law, the trustee must comply with the Uniform Principal and Income Act, or other state statutes of like effect, in allocating receipts and disbursements between trust income and principal.
Under the Uniform Principal and Income Act, “all ordinary expenses incurred in connection with the preservation of trust property including ordinary repairs” are allocated to income. Extraordinary repairs are allocated to principal. Ordinary repairs are repairs required by day-to-day wear and tear. Extraordinary repairs are repairs required by “an unusual or unforeseen occurrence that does not destroy the asset but merely renders it less suited to its intended use, a repair that is beyond the usual, customary, or regular kind.”
Here, the $50,000 roof repair was extraordinary because it was required by an unforeseen occurrence, a fire. It should therefore have been allocated to principal, not income, and paid from the trust principal’s $120,000 in liquid assets. This conclusion is bolstered by the fact that, had the trustee obtained insurance on the property, the insurance proceeds, representing the value of needed repairs, would have been allocated to principal.
[NOTE: The duties discussed in this section are sometimes referred to as an aspect of the duty of impartiality.]
ISSUE: Upon Albert’s death, should the trust principal be distributed to Betty’s husband, Betty’s daughter, equally to both of them, or to the testator’s heirs? ANSWER: Under the common law, upon Albert’s death, the trust principal should be distributed to Betty’s husband because she devised her vested remainder in the trust to him.
Under the terms of the trust, the testator created a life estate in Albert and a remainder interest in Betty. Under the common law, Betty’s interest was vested because it was subject to no contingencies (such as “to Betty if she survives Albert”) that would cause her to lose her interest should she predecease Albert. Vested remainders are devisable. Thus, if the remainderman is not living when the remainder becomes possessory, it passes to the devisee of the interest under the deceased remainderman’s will.
Here, trust principal became possessory at Albert’s death, and Betty was not living at that time. The trust principal thus should go to the devisee named in Betty’s will, her husband. Under the common law, the testator’s son would not take a share of trust principal as there is no reversionary interest to pass to the testator’s heirs.
[NOTE: If Betty’s trust interest were subject to a survivorship contingency, that would have caused Betty’s interest to fail because she predeceased Albert. In that case, her interest would have reverted to the testator’s estate. In such case, it would have passed to his heirs if he died intestate or to his beneficiaries if he died with a will.]
ISSUE: Can the trustee of a revocable trust, who is required by the terms of the trust instrument to pay all trust income to the settlor, accumulate income upon the settlor’s written direction? ANSWER: Yes. It was proper for the trustee to accumulate trust income because Settlor retained a power to revoke the trust during her lifetime in a written instrument, and the trustee accumulated income based on written directions from Settlor during her lifetime.
A retained power to revoke a trust includes the power to modify or amend the trust instrument. Courts have taken this position to avoid the triumph of form over substance; the contrary position would require a settlor who wants to amend a trust and lacks clear authority to do so to first revoke, and then to completely restate, the terms of the trust with the intended amendment. Such cumbersome formalities should not be encouraged; thus, the power to revoke includes the power to amend.
The Uniform Trust Code (UTC) follows this approach; under the UTC, a trust is both revocable and amendable unless the trust instrument expressly provides otherwise. Under the UTC, the power to revoke or amend is exercisable by will unless, as here, the trust instrument provides otherwise.
Here, the trust instrument required the trustee to distribute all trust income to Settlor during her lifetime; Settlor retained the power to revoke the trust “during Settlor’s lifetime”; and the trustee accumulated trust income at Settlor’s written direction, drafted during her lifetime. Settlor’s written direction effectively amended the terms of the trust as initially created. Thus, no improper accumulation of income occurred.
ISSUE: Can the holder of a testamentary power of appointment exercisable in favor of the holder’s children exercise the power by appointing trust assets to the holder’s grandchildren? ANSWER: No. Settlor could not appoint an interest in the trust to her son’s children (Settlor’s grandchildren) because they were not permissible objects of her power of appointment.
The donee of a special (nongeneral) power can appoint the property over which the power is exercisable only to “permissible appointees” or “objects” of the power. Permissible appointees are “the persons to whom an appointment is authorized.” Appointments to impermissible appointees are invalid. However, objects of a power include only those who receive a “beneficial interest.” Thus, when, as here, property is appointed in further trust, the trustee is not an impermissible appointee.
Although the trustee is not an impermissible appointee, Settlor’s grandchildren (her son’s children) are impermissible appointees. Under the trust instrument, Settlor’s “children” were the only permissible objects of her testamentary power of appointment. It might be argued that Settlor intended to include more remote descendants, such as grandchildren, when she used the word “children” when creating the power of appointment. However, Settlor’s will – executed contemporaneously with the trust instrument – includes a $50,000 bequest to her “descendants other than my children,” clearly evidencing Settlor’s ability to distinguish between children and more remote descendants. The argument that Settlor intended to include more remote descendants in the term “children” is thus highly likely to fail, and Settlor’s appointment of trust assets to the children of Settlor’s son thus should be ineffective.
The trust instrument allowed for amendments during Settlor’s lifetime by a written instrument. However, the appointment in Settlor’s will cannot be treated as an amendment made during Settlor’s lifetime by a written instrument.
ISSUE: Who takes trust assets that have been impermissibly appointed? ANSWER: As the named taker in default of appointment, Charity is entitled to the portion of the trust ineffectively appointed to Settlor’s grandchildren. It is not entitled to any interest appointed to the son.
“If part of an appointment is ineffective and another part, if standing alone, would be effective, the effective part is given effect, except to the extent that the donee’s scheme of disposition is more closely approximated by concluding that some or all of the otherwise effective part should be treated as ineffective.” To the extent that a power is ineffectively appointed, the ineffectively appointed property passes to the so-called “taker in default of appointment” (here, Charity) designated by the donor of the power (here, Settlor).
Thus, assuming that the appointment to Settlor’s son’s children is ineffective, the share they would have received upon the son’s death passes to Charity. The appointment in trust to the son is permissible. Thus, Charity has no claim to the trust income interest appointed to the son.
ISSUE: Can the surviving spouse of the decedent settlor of a revocable trust claim an elective share of assets in that trust even though the spouse is not a named beneficiary of the trust? ANSWER: Yes. Settlor’s husband may be entitled to an elective (i.e., forced) share of Settlor’s revocable trust assets under the illusory-transfer doctrine, the fraudulent-transfer doctrine, or a like doctrine. He is also entitled to one-third of the probate assets.
Although many states have statutes under which a surviving spouse’s elective (forced) share of the decedent spouse’s estate extends to assets placed into a revocable trust by the decedent spouse, here, the jurisdiction’s elective-share statute provides that the spousal right of election extends only to probate assets. Because the disposition of assets in a revocable trust is determined by the terms of the trust instrument, trust assets are not probate assets. Thus, the statute does not give Settlor’s husband any claim to assets in her revocable trust. Assuming that the husband has no claim to the trust assets, he will not claim an elective share because that share ($33,333) would be less than the amount he is entitled to under the will ($50,000).
However, in many states, case law permits a surviving spouse to claim an elective share of assets contained in a revocable trust under either the illusory-transfer doctrine, the fraudulent-transfer doctrine, or a like doctrine.
Under the illusory-transfer doctrine, a surviving spouse can reach assets transferred during the marriage by the deceased spouse into a revocable trust on the theory that the transfer is economically “illusory” because, by the simple expedient of exercising the power of revocation – typically with nothing more than a signature on a piece of paper – the deceased spouse could have recaptured the assets she had placed in the trust.
Under the fraudulent-transfer doctrine, a surviving spouse can reach assets transferred into a revocable trust on the theory that, as to the surviving spouse, the transfer was “fraudulent.” The assumption behind this doctrine is that a state statute providing surviving spouses with an elective-share entitlement gives spouses a legitimate expectancy in assets that would have been included in the decedent spouse’s probate estate but for their transfer into a revocable trust; such a transfer is treated as defrauding the surviving spouse of his or her expectancy.
Thus, if this jurisdiction recognizes one of these doctrines or another similar doctrine, Settlor’s husband will be entitled to receive one-third of the combined probate ($100,000) and trust estate ($500,000) or $200,000 (1/3 of $600,000). However, this $200,000 would be reduced to $150,000 to take account of the fact that he received $50,000 under the will.
Not all jurisdictions recognize such a doctrine, however. In those jurisdictions that do not, the husband would receive nothing beyond the $50,000 he would receive under the will because that amount exceeds the elective share (1/3 of $100,000).
[NOTE: If an examinee concludes that the husband can elect against the trust assets, the examinee may also discuss who would bear the burden of paying the husband’s share. No credit should be given for this discussion, as the payment issue is beyond the scope of the question.]
%] ISSUE: Is the trust condition providing for the termination of an income interest upon marriage invalid as a matter of public policy? ANSWER: No. The son’s income interest in the trust would not terminate upon his marriage because the condition against marriage is void as a matter of public policy.
Provisions of trusts that violate public policy are void. Trust provisions that restrain a first marriage have generally been held to violate public policy. Under the Second Restatement of Property, a provision restraining any first marriage is invalid and the transfer takes effect “as though the restriction had not been imposed. “The common law has a well-defined interest in preserving freedom of marriage and in the preservation of the family relation. Hence provisions in a trust instrument which provide that a beneficiary shall have no interest under the trust unless he obeys the instructions of the settlor regarding marriage may be held illegal as against public policy.” Although courts have upheld some restrictions on marriage – for example, remarriage – none have upheld a complete restraint on a first marriage. Thus, because the son’s income interest would terminate upon his marriage, no matter what the circumstances of that marriage, the provision is void and the son’s income interest continues.
A restraint on marriage might be upheld if the trustee’s motive was merely to provide support for a beneficiary while the beneficiary is single. Here, there are no facts to support that motive. In fact, because this is a mandatory income payout trust, the trust income is payable to the son without regard to his support needs.
ISSUE: Did the trustee violate his duty of loyalty by purchasing the stock of the closely held corporation from the trust and, if so, what damages or other remedies are the trust beneficiaries likely to obtain? ANSWER: Yes. The trustee breached his duty of loyalty by purchasing stock from the trust, an act of self-dealing. In such a case, trust beneficiaries may obtain an order setting aside the transaction or seek damages based on the difference between the purchased assets’ fair market value at the time of purchase and the sales price paid by the trustee.
A trustee owes a fiduciary duty of loyalty to a trust; self-dealing, such as a purchase of trust assets by the trustee in his individual capacity, violates this obligation. Under the “no further inquiry” rule, there is no need to inquire into the motivation for the self-dealing transaction or even its fairness.
Any trust beneficiary can cause a self-dealing purchase by a trustee to be set aside or obtain a damages award. If a beneficiary elects to set aside the transaction, the trust property purchased by the trustee is returned to the trust and the amount the trustee paid for the property is refunded by the trust. If a beneficiary seeks damages, those damages are based on the difference in the fair market value of the trust assets at the time of the self-dealing transaction and the amount paid by the trustee. Where, as here, the assets purchased by the trustee have declined in value since the self-dealing transaction, trust beneficiaries are likely to seek damages instead of setting aside the transaction.
Here, the beneficiaries should elect to seek damages from the trustee, not rescission. First, with rescission, the trustee would return the shares to the trust, and the trust would have to refund the purchase price to the trustee. This would leave the trust with assets worth only $450,000. Furthermore, because of the market declines, the trust assets are currently worth only $1,000,000; thus the trust doesn’t have sufficient assets to refund the purchase price. On the other hand, by seeking damages, the trust would collect $300,000, representing the difference between the value of the shares when purchased by the trustee ($1,500,000) and the purchase price ($1,200,000), leaving the trust with $1,300,000 in assets.
The trustee also breached his duty of care when selling the stock because of his failure to test the market.
ISSUE: Did the trustee violate the prudent investor rule by investing trust principal in a balanced portfolio of mutual funds with potential for growth and current income and retaining those investments after they declined in value? ANSWER: No. A trustee has a duty to invest trust assets in a prudent manner. Here, there are no facts suggesting that the trustee breached any prudent investment duty with respect to the selection and management of the investments he made.
Under the Uniform Trust Code, a trustee must administer “the trust as a prudent person would, using reasonable care, skill, and caution.” One of the hallmarks of prudent investing is diversification. A balanced portfolio reduces aggregate risk by investing in different investment categories. Diversification thus is strong evidence of prudent investing. Indeed, failure to diversify is likely the reason why the trustee in this case was advised to sell the closely held corporate stock.
“A trustee’s investment and management decisions respecting individual assets must be evaluated not in isolation but in the context of the trust portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the trust.” The trustee should consider the purposes, terms, distribution requirements, and other circumstances affecting the trust. The prudent investor rule applies to both investment and management decisions. Management includes monitoring; thus, the trustee has a duty to monitor investments prudently made to assure that retention of those investments remains prudent. If retention is not prudent, the trustee should sell the imprudent investments and reinvest the proceeds in prudent investments. A trustee, however, is not liable for declines in value due to a downturn resulting from general economic conditions.
Here, the trustee’s investment of the sale proceeds seems to satisfy the diversification requirement. The trustee selected a balanced group of mutual funds; the portfolio included both stock and bond funds; it contained both growth and income funds. The trustee also appears to have considered the needs of both the income beneficiary and remainderman; growth funds are aimed at achieving principal appreciation and income funds at producing current income. The funds’ decline in value during a period of general economic decline – when most types of investments may well have fallen in value – does not evidence lack of prudence, and there are no facts to show any failure to monitor the portfolio.
ISSUE: How should rents, dividends, and sales proceeds received by the trustee prior to receipt of the son’s letter have been allocated between trust income and principal? ANSWER: Cash dividends and rents are allocable to income; sales proceeds and stock dividends are allocable to principal. Items allocable to income for the period prior to the son’s attempted disclaimer were distributable to the son.
Receipts earned during the administration of a trust are allocable either to income or to principal. Almost all states have adopted the most recent or an earlier version of the Uniform Principal and Income Act (the Act), which specifies how such receipts should be allocated.
Under the Act, rents and cash dividends received from a corporation are allocable to income and are distributable to the income beneficiary of the trust.
Sales proceeds and dividends paid in the stock of the distributing corporation are allocable to principal and added to the principal of the trust.
Here, the cash dividends and office building rents should have been allocated to income and, until the trustee received the son’s letter, should have been distributed to him as the sole income beneficiary of the trust. The stock dividend and proceeds from the sale of the office building should have been allocated to principal and held by the trustee for future distribution to the ultimate remaindermen of the trust.
