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The Pennsylvania Uniform Principal and Income Act provides trustees with more discretion in administering a trust for optimal growth and income

On July 15, 2002, the Pennsylvania Uniform Principal and Income Act (the Act) took effect. You may be affected by this Act if you are currently the income or remainder beneficiary of a trust or if you are interested in creating a trust in the future.

Discretionary Income Distributions
The Act consists of two primary parts intended to provide a trustee more discretion in administering a trust for optimal growth and income. The first part allows a trustee to use his or her discretion in making income distributions from either income or principal under a power to adjust between income and principal. This means that a trustee can invest for growth for the future of the remainder beneficiary, but distribute some of the principal now to provide for the current needs of the income beneficiary.

Conversion to a Total Return UniTrust (TRU)
The second part of the Act allows a trustee to convert a trust to a Total Return Unitrust (a TRU). TRUs have been in existence for years, however, they have only been used for charitable trusts. Having been successful in the charitable realm, states are now enacting legislation to bring the TRU to the private trust realm. Pennsylvania is among the first states to enact such legislation. Delaware was the first.

In a traditional trust, all the income generated by the trust (usually interest and dividends) must be distributed to the income beneficiary and the principal is left to grow for the remainder beneficiary. The trustee is under a duty not to favor either the income beneficiary or the remainder beneficiary over the other. This situation breeds conflict among these three parties. The income beneficiary wants as asset portfolio in the trust that will generate the highest and steadiest amount of income. This desire tends to favor investments such as bonds and money market funds that will generate a steady level of income now rather than a high rate of return in the long run. The remainder beneficiary on the other hand wants the long-term growth associated with investments heavy in stocks.

The trustee has a duty to accommodate both of these competing desires, but not at the detriment of either one. Therefore, what often happens is that the trust assets are invested in a mix close to 50/50 in income and growth that compromises the desires of both beneficiaries by not maximizing either growth or income.

Conversion to a TRU will provide an income stream of 4% of the net fair market value of the trust's assets averaged over the three years prior to the current year or over the existence of the trust, whichever is shorter. The genius of this concept is that it eliminates the potential conflict inherent in the traditional trust among the trustee, the income beneficiary and the remainder beneficiary. With a TRU, all three parties now benefit by the same ultimate goal of growth in the trust. As the trust grows, so will the income payout to the income beneficiary, the distribution to the remainder beneficiary and the trustee's commission, if applicable.

Conversion to a TRU or use of a power to adjust will likely have Federal estate and generation skipping tax consequences. The Act will be of most benefit to those trusts that were established for long-term growth and continuance. It would not be beneficial for trusts whose primary asset is a closely held business.

MacElree Harvey
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