If you are considering converting an income-only trust to a unitrust, think again.
As the name suggests, an income-only trust is one in which the current beneficiary has access to the net income, but not the principal, of the trust. Once a common feature of the trust landscape, income-only trusts are rarely encountered today. Low interest rates, combined with the inherent inflexibility of the income-only approach, make such trusts unsuitable for most clients’ purposes.
More importantly, the income-only arrangement creates a conflict between beneficiaries. The current beneficiary would prefer the trust be invested in low-growth, high-yield assets. On the other hand, the remainder beneficiaries want the trust invested in high-growth, low-yield assets. This puts the trustee in a precarious position.
In order to balance the interests of the beneficiaries, Tennessee’s version of the Uniform Principal and Income Act (UPIA) authorizes a disinterested trustee to convert an “income trust” to a “total return unitrust” without court approval. A total return unitrust is a trust in which the net income of the trust is deemed to be a fixed percentage of the value of the trust determined at least annually. The fixed percentage cannot be less than 3% or more than 5%. This allows both the current and the remainder beneficiaries to benefit in the growth of trust assets.
At least, that used to be the law in Tennessee. Earlier this year, the Tennessee Legislature quietly changed the unitrust statute. The previous version of the rule read in part as follows:
This section shall be construed as pertaining to the administration of a trust and shall be available to any trust including a trust initially converted to a total return unitrust under the laws of another jurisdiction that is administered in Tennessee under Tennessee law or to any trust, regardless of its place of administration, whose governing instrument provides that Tennessee law governs matters of construction or administration unless: (A) The governing instrument reflects an intention that the current beneficiary or beneficiaries are to receive an amount other than a reasonable current return from the trust;
The new rule tacks the following self-defeating provision to the end of the above paragraph:
or gives the trustee no discretion to distribute any trust principal to the income beneficiary under any circumstances;
In other words, if a trust is truly an income-only trust, the trustee can no longer convert it to a unitrust. However, if the trust gives the trustee any amount of discretion over principal, no matter how minor, the new rule would not apply.
The rule became effective on May 3, 2018. It is not clear what prompted the change. Presumably bad facts led to bad law.
Efforts are under way to restore the old version of the statute. Until that happens, it may be necessary to look at other options under the Tennessee Trust Code, such as a trust modification under T.C.A. § 35-15-411.
Posted by Joel D. Roettger, JD, LLM, EPLS