By Lyman W. Welch
Total return legislation is sweeping across the country.
This article examines the fundamental policy differences of these
Sidley Austin Brown & Wood
(Adapted from article published in Trusts & Estates Magazine
Thirty-three states plus the
District of Columbia have enacted total return legislation in
the past three years. Six additional states have such laws pending
in their legislature. (See Exhibit) What explains this crescendo
of legislative activity? The driving force is the impact of modern
investment policy on the traditional method for determining how
much a trust pays to current beneficiaries.
Trusts commonly specify that
trust accounting income is payable to the current beneficiary.
In the past, a trustee could comply with prudent man investment
duties by buying and holding high quality bonds, supplemented
by a usually smaller holding of conservative stocks, and expect
to preserve value and produce an acceptable level of income.
But the investment environment has changed. Trustees now face
new economic realities including rapid changes in corporate finance,
investment products and practices, as well as the compelling fact
that the most attractive investments often pay little or no income.
Moreover, the shift to the prudent investor rule requires a trustee
to manage the trust portfolio dynamically, managing risks and
seeking investment returns judged appropriate to the facts and
circumstances of the trust and its beneficiaries.
The striking decline of distributable
trust income as a percentage of total investment return too often
creates unfairness to the current beneficiary. For example, a
portfolio invested 60 percent in large cap stocks and 40 percent
in intermediate corporate bonds yields less than 3 percent compared
to more than 5.5 percent ten years ago. Yet the prudent trustee
might expect a long-term average annual total return from this
portfolio of 8 percent or more. Conflict results: how a trustee
would invest to achieve the best total return too often conflicts
with how a trustee would invest to achieve fair or necessary income
distributions. This increases trustee stress, litigation risk
and disputes, all of which call out for a solution.
Total Return laws have been
adopted to help solve this problem. This legislation applies
to so-called income trusts: that is, trusts that determine the
return payable to current beneficiaries by reference to trust
accounting income. These new laws liberate the trustee to invest
as the trustee thinks best for the maximum total return suitable
to the purposes and circumstances of the trust without regard
to whether that return is from income or capital appreciation.
In general, two different types of total return laws have been
The first approach grants
trustees an equitable adjustment power. This empowers the trustee
to increase (or decrease) distributable income by transferring
principal to income (or vice versa) to the extent the trustee
determines necessary to comply with the trustee's duty of impartiality
to both current and future beneficiaries.
The power to adjust was first
adopted by the National Conference of Commissioners on Uniform
State Laws in 1997 as part of its revised version of the Uniform
Principal and Income Act ("UPAIA"). This revised act includes
in section 104 the equitable adjustment power described above.
In the thirty jurisdictions
that have adopted UPAIA section 104 (See Exhibit), the trustee
of every trust for which income determines the amount distributable
to current beneficiaries has a duty to consider annually (or at
least periodically) whether the trustee's duty of impartiality
requires an adjustment between income and principal. For example,
if the trustee's investment decisions reduce income distributable
to the current beneficiary below the level the trustee determines
appropriate, the trustee has discretion to transfer a compensating
amount from principal to income.
A second approach grants to
the trustee a power to convert an income trust to a unitrust.
This is a different solution to the same problem. Conversion
to a unitrust changes the definition of income for the trust,
substituting a distributable amount determined as a percentage
of trust assets revalued at least annually. The consequence is
that current and future beneficiaries share as partners in the
total investment results, and the trustee's investment decisions
are no longer inhibited by distribution requirements. The unitrust
is increasingly popular among estate planners, and now ten states
have adopted total return legislation permitting trustees to convert
income trusts to a statutory unitrust, and at least four additional
states are considering such legislation. (See Exhibit)
Some states have adopted hybrid
approaches combining part or all of both the unitrust conversion
and equitable adjustment methods. (See Exhibit)
Fundamental policy differences
This article does not propose
to detail the multitude of variations in the 39 different total
return statutes. Rather it will consider the fundamental policy
differences between the two primary forms of such legislation.
All the total return laws
give the trustee discretion to change the definition of income,
for trusts to which they apply, in order to provide fairer sharing
of total return by current and future beneficiaries. The key
policy difference distinguishing the various laws is the extent
of discretion granted to the trustee, as determined by the standards
limiting the trustee's exercise of discretion. Such standards
establish the guidelines for the trustee, the expectations of
the beneficiaries and the principles by which the trustee's actions
will be judged.
Granting trustee discretion
is a double-edged sword. It confers flexibility to accomplish
trust purposes, but also increases risks of mistake, abuse and
dispute. Each state enacting total return legislation must make
value judgments balancing the perceived need for discretion against
these risks, based upon the unique values, presumptions and historic
experience of the community and its leaders. An examination of
the key design choices made in the different total return laws
demonstrates a wide variety of views on how much trustee discretion
Standards governing equitable
adjustment. Impartiality (or partiality) to the current and
future beneficiaries as provided by the terms of the trust sets
the standard governing exercise of the equitable adjustment power.
It appears that all of the states adopting the equitable adjustment
form of total return legislation incorporate verbatim from UPAIA
the standard that:
"A trustee may adjust between principal
and income to the extent the trustee considers necessary if
the trustee invests and manages trust assets as a prudent investor,
the terms of the trust describe the amount that may or must
be distributed to a beneficiary by referring to the trust's
income, and the trustee determines that the trustee is unable
to comply with [the duty to administer the trust] impartially,
based on what is fair and reasonable to all of the beneficiaries,
except to the extent that the terms of the trust clearly manifest
an intention that the fiduciary shall or may favor one or more
of the beneficiaries." 
The comments to UPAIA section 104
elaborate that: "section 104 does not empower a trustee to increase
or decrease the degree of beneficial enjoyment to which a beneficiary
is entitled under the terms of the trust, rather, it authorizes
the trustee to make adjustments between principal and income that
may be necessary if the income component of a portfolio's total
return is too small or too large because of investment decisions
made by the trustee under the Prudent Investor Rule."
This standard establishes
parameters limiting the trustee's exercise of the equitable adjustment
power. As the above quoted comment makes clear, the amount of
any compensating adjustment made under section 104, at least as
envisioned by National Conference of Commissioners on Uniform
State Laws, appears to be confined to compensating for the marginal
decrease or increase in trust income resulting from the trustee's
investment decisions. This leaves considerable latitude for the
trustee to exercise judgment on whether and how much compensating
adjustment is appropriate, but arguably limits such adjustments
to the incremental amount that trust accounting income is increased
or decreased by the trustee's investment decisions.
Broad interpretation of
the equitable adjustment standard. It is important to note
that the equitable adjustment statutory language alone, when considered
separately and apart from the uniform act commentary, can be read
more broadly to authorize a trustee to make adjustments as the
trustee deems necessary to promote fair sharing of total return
among beneficiaries, in accordance with their interests as provided
by the terms of the trust.
Therefore a trustee arguably
could properly administer the statutory equitable adjustment power
without exclusive regard to the incremental impact of investment
decisions on trust accounting income. For example, a trustee
could use as a guideline in determining appropriate equitable
adjustments: (a) a unitrust calculation, (b) an inflation adjusted
annuity value, (c) the discounted value of cashflows statistically
likely to be distributed to the current and future beneficiaries
respectively from a chosen distribution amount or percentage,
(d) a floating index determined by the trust's own historic returns,
(e) a floating index determined by selected market indicators,
or (f) a wide variety of hybrid methods for determining a fair
current return. Any of these alternative methods for implementing
the equitable adjustment power would still be governed by and
literally satisfy the statutory standard of impartiality.
A broad interpretation of
the equitable adjustment power is warranted because it is unclear
what methodology to use in determining the impact of investments
on distributions over time. In addition, more than just
the trustee's investment decisions impact current returns. Changed
economic circumstances also have caused trust accounting income
often to be less than a fair current return as a percentage of
total return in many cases. The statutory language lends itself
to interpretation that the equitable conversion power authorizes
a trustee to correct this unfairness. However, whether equitable
adjustment statutes will be administered and interpreted liberally
or restrictively in the various states is yet to be seen.
Impartiality is relative
to the terms of the trust. To understand the equitable adjustment
power, it must be noted that the impartiality standard itself
requires judgment. It does not simply mean treating current and
future beneficiaries equally, but rather requires subjective judgment
on how investment returns should be shared between current and
future beneficiaries in carrying out the terms of the trust.
Significantly, it appears that all of the equitable adjustment
statutes incorporate verbatim UPAIA's definition of "terms of
a trust". This key phrase in the statutory standard is defined
broadly to mean "the manifestation of the intent of a settlor
or decedent with respect to the trust, expressed in a manner that
admits of its proof in a judicial proceeding, whether by written
or spoken words or by conduct."
 Therefore, the equitable adjustment statutes
ask the trustee to look beyond the four corners of the trust instrument
and to make subjective judgments about the purposes of the trust,
the intent of the settlor, whether some beneficiaries are intended
to be favored, and to determine what is a fair and reasonable
current return in the context of the facts and circumstances of
unitrust conversion. In contrast, the unitrust conversion
statutes provide a management by exception approach. Rather than
granting discretion to make discrete, subjective judgments about
income adjustments every year (or at least periodically), they
grant discretion to elect into a relatively fixed regime of determining
current return by an objective percentage of asset value. Some
versions of the unitrust conversion approach grant limited discretion
(such as proposed statutes pending in Illinois 
and Pennsylvania  and one enacted in Maine  ) and impose as a standard
for conversion that it "enable the trustee to better carry out
the purposes of the trust." Other versions of the unitrust conversion
approach grant broad discretion (such as those adopted in Delaware  , Florida  and South Dakota  ) and provide no specific
standard limiting the trustee's decision to convert to a unitrust
(other than the implied duties of fairness and impartiality).
Importantly, liberal unitrust conversion statutes grant the trustee
discretion to select any distribution percentage which is not
less than 3 nor more than 5 percent, to set whatever policies
the trustee deems appropriate for valuation and administration
procedures, and to decide without restriction how frequently the
trustee may change the distribution percentage as well as valuation
and administrative procedures.
Which method is better?
Which type of total return
legislation is preferred depends upon one's values and presumptions
about trustees, trust beneficiaries, trust investments and trust
purposes. The more one believes it best to endow trustees with
authority to fine-tune the current payout to fit changing circumstances,
the more one will prefer a form of total return legislation granting
broad discretion to the trustee, such as UPAIA's equitable adjustment
power or the liberal unitrust conversion approach of Delaware.
On the other hand, the more one believes it best to establish
definite rules, limit the range of discretion granted to trustees,
and reduce the number of issues and opportunities for mistake,
abuse and dispute, the more one consequently will prefer a limited
unitrust conversion approach, such as the pending Pennsylvania
statute. The maximum discretion and flexibility would be provided
by combining alternative options of both an equitable adjustment
power and a liberal unitrust conversion power, as exemplified
by the statute Florida recently adopted.
is yet to be learned about how best to design and administer total
return trusts in drafting estate plans and advising clients.
The new models for total return trust plan alternatives that will
evolve and become standard forms for future generations are undreamed
of today. Existing total return laws are likely to be revised
and redirected as new concepts develop in mechanisms to govern
distributions dynamically in response to investment results and
spending needs, in formulations for defining beneficial interests,
priorities and purposes, and in architecture for layered decision-making
authority and control. In addition, new methods are needed to
coordinate the distributions and investments of multiple trusts
created at different times by several grantors for a single, extended
present, total return laws enacted to date contribute invaluable
new authority for trustees and beneficiaries to resolve conflicts
which too often occur when trust investment and distribution policies
clash. Care, skill, and creativity will be needed to craft the
best solutions for the administration and interpretation of these
new statutes. Trustees, trust beneficiaries and their advisors
should be proactive in taking advantage of these new opportunities.
JURISDICTIONS THAT HAVE TOTAL RETURN LEGISLATION
ENACTED, ADOPTED OR PENDING
New Hampshire (UC-P)
New Jersey (EA)*
New Mexico (EA)
New York (B)
North Dakota (EA)
District of Columbia
Rhode Island (EA-P)
South Carolina (EA)
South Dakota (UC)
West Virginia (EA)
- Codes in Parenthesis Indicate:
· EA =
UPAIA §104 equitable adjustment power
· UC =
· B =
Both unitrust conversion and equitable adjustment power
· P =
- 33 jurisdictions have enacted or adopted total return laws.
· 23 have
UPAIA §104 equitable adjustment power only
· 3 have
unitrust conversion only
· 7 have
both unitrust conversion and equitable adjustment power
- 7 additional states have total return laws pending in the
· 3 have
UPAIA §104 equitable adjustment power only
· 2 have
unitrust conversion only
· 2 have
both unitrust conversion and equitable adjustment power
- Asterisks indicate New Jersey and Louisiana adopted (and Ohio
has pending) UPAIA §104 with a unitrust safe harbor.
- Above information believed current as of May 31, 2002.
 UPAIA sections
103 and 104, emphasis added
 UPAIA section
Senate Bill 1697, now pending in the Illinois House of Representatives.
20 Pa. C.S.A. § 8105.
 Del. Code.
Ann. tit. 12, § 3527 (2001).
 2002 Fla.
Laws Ch 42.