Trust Accountings: Allocations at Death, Principal and Income Designations – Does any of it Really Matter?

Many trustees are aware that there are statutory requirements to provide beneficiaries with annual accountings unless the trust instrument states otherwise.  However, many trust accountings fail to provide proper designations for how assets are allocated and also fail to account for principal and income, instead just clumping everything together in the accounting.

However, principal and income designations often do matter and can be critical.  Take for example the situation of a standard A/B trust after the death of a spouse.  In most cases the trust is split into an “A” trust (“Survivor’s Trust”) and a “B” trust (“Bypass Trust”).  The “B” trust is normally irrevocable whereas the “A” trust is revocable by the surviving spouse.  Also, the “A” trust can often be spent however the surviving spouse wishes whereas the “B” trust may not. 

In many cases an unknowing surviving spouse just spends trust money without properly allocating assets to the “A” and “B” trusts or separating the assets between the two trusts.  So take the hypothetical where there is a $1 million trust all in a single bank account bearing interest at 1% annually and it is to be split between an “A” trust and “B” trust with $500,000 in each at the death of the first spouse.  Let’s also say this is a second marriage and each spouse has three children from their first marriage.  Each subtrust will generate $5,000/year in annual income.  The surviving spouse in this hypothetical is entitled to income from the irrevocable “B” trust of $5,000 a year.  However, for purposes of this hypothetical the surviving spouse is not allowed to invade the principal of the “B” trust until the “A” trust is exhausted.  What this means is that if the surviving spouse needs $50,000/year to survive, then the surviving spouse must first spend such funds from the “A” trust.  What will happen is that the “B” trust will stay at $500,000, but the “A” trust will become smaller and smaller over time.  If the two subtrusts are not properly accounted for then it is possible that both subtrusts are reduced by $20,000 in principal each.  This “mistake” would result in the beneficiaries of the “A” trust getting $20,000 more than they should and the beneficiaries of the “B” trust getting $20,000 less.

Keep in mind that not all trusts are the same and the above is merely a hypothetical example.  If you feel that your trust was not properly allocated or that distributions of income and principal were not done properly, then feel free to contact the attorneys at Demiris & Moore for a free consultation.