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Uniform Prudent Investment Standards
By Dr. David Edward Marcinko; MBA, CMP™
By Tom Muldowney; MSFS, CFP®, AIF®, CMP™
By Hope Rachel Hetico; RN, MHA, CPHQ™, CMP™
The physician-investor dichotomy, income now versus growth for later, is not unique. Trusts; that have the potential to span decades, usually place the interests of the income beneficiary at odds with the remaindermen.
Conflicting Goals
Historically, trustees invested these irrevocable trust assets in bonds so as to generate the necessary income for the income beneficiary. But this led to conflicts…investing in bonds provides little growth of either the investment asset base or the income generated thereon. Interestingly, this has also placed the interests of the remaindermen at odds not only with the income beneficiary but with the trustees who have been charged with the duty of stewarding these assets for the benefit of both generations. This conflict of the generations has led to some surprising results both in practice and in the courts.
“Total Return Trust”
Income beneficiaries want current cash flow, remaindermen want growth and trustees want to minimize the exposure to liability. Notice the subtle difference … rather than “income” (dividends and interest) income beneficiaries want cash flow. They generally do not care about the source from which the cash flow was generated. Recognition of this subtle but important difference has led to the development of Uniform Prudent Investment Standards and the introduction of the “Total Return Trust.”
Uniform Prudent Investment Standards
The Uniform Prudent Investment Standards (agreed upon by legislatures of all 50 states) identify that for a trustee to be a “prudent investor”, investments that are allocated across a broad spectrum of investment asset classes, provides the greatest protection from investment risk. But; because this allocation across a broad spectrum must – by definition – include stocks, the potential for income in its technical sense (interest and dividends) must be reduced. The use of a “Total Return Trust” addresses and solves this problem.
Combination of Assets
A total return trust thus allows a trustee to manage a portfolio of assets commensurate only with the volatility risk that the trustee identifies is appropriate for the trust. This gives the trustee the ability to invest in a combination of assets that include stocks, bonds and other investment assets. The purpose of the total return trust includes safety and protection of the assets with a reasonable growth rate, from which a periodic ‘unitrust’ cash flow may be withdrawn for the income beneficiary. Unitrust cash flow is based on the recognition that a stated percentage withdrawal from trust corpus, each year, may be made to the income beneficiary without regards to the source of that cash flow, whether it be from income, or from corpus. The Unitrust cash flow recognizes that from time to time volatility in the equity marketplace will cause the trust corpus to fluctuate, sometime below that amount that was originally invested.
Cash Flows
Using this technique, as long as assets of the trust portfolio grow and the long term cash flow withdrawal rate is less than the long term growth rate, several benefits to all of the parties will inure: Cash flow to the income beneficiary will be maintained; cash flow to the income beneficiary will increase as the asset base increases; asset growth will satisfy the needs of the remaindermen; the trustee will be secure in knowing that he has satisfied his fiduciary duty to serve both the income beneficiary and the remaindermen. A substantial side benefit for the income beneficiary is that the cash flow will include not only income (dividends and interest) but will also include distributions of long term capital gains (which enjoy a lower annual tax rate.)
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Filed under: Estate Planning, Insurance Matters, Investing, Retirement and Benefits, Risk Management | Tagged: Estate Planning, trusts | 2 Comments »
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