Insights

Trust Fund Erosion: Is it Better to Have Smaller Payments in the Long Run?

The Importance of Balancing Trust Income and Capital Preservation

Trusts are set up for a variety of reasons, such as tax efficiency, protecting funds for those under 18 or providing an income for family members in the future. However, as circumstances change and non-ideal situations arise, a Trust can cease to work as expected.

We have compiled a case study into how a Trust can cease to be effective and what problems can arise if you increase the monthly allowance (names, dates and amounts have been changed for anonymity).

Beneficiary X’s Case Study

Beneficiary X, the current principal beneficiary of a Trust, has seen their personal circumstances change and has requested several changes to their Trust payments over the past few years. These changes were made to accommodate specific financial needs, including an increased monthly allowance and an additional monthly payment for the client’s child. Although these amendments address immediate financial requirements, they will impact the Trust’s capital in the long-term. The beneficiary originally received a monthly allowance of £3000 but asked for an extra £2000 to be directed towards supporting their son. The total annual payment has risen from £36,000 to £60,000, reflecting a significant increase in financial support. Although the payments are allowed by the terms of the trust, they exceed the income generated and so the trust capital will be eroded.

Erosion of Trust Capital

The beneficiary was emailed in the summer of 2019 by the Trustees, who expressed concern that the elevated monthly payments will continue to erode the Trust’s capital. As each year passes the position is likely to be worse as the capital fund shrinks thus reducing the income that is generated and, in turn further eroding the trust capital. Many trusts have a limit on the amount of trust capital which can be paid out; in this case it was 50% of the trust capital.

The trustees informed the beneficiaries that once 50% of the Trust’s capital had been paid out, the principal beneficiary would be entitled only to the actual income generated by the Trust, with no top-up from the remaining capital of the trust. This income will be substantially less than the current monthly allowances, leading to a significant reduction in the client’s future financial support.

While the beneficiary has benefits from increased financial support in the short term, there is a trade-off in terms of the Trust’s long-term sustainability and the support available to the beneficiary.

In circumstances like this, it is essential for the beneficiaries to weigh their current financial needs against the need for sustained support over the years. The Trustees can and should assist with that process explaining the Trust’s ability to provide financial assistance and how that will diminish, emphasising the importance of financial planning and prudent use of Trust resources.

Conclusion

This case underscores the delicate balance between meeting immediate financial needs and preserving the long-term viability of a Trust. Trustees and beneficiaries must carefully consider the impact of their financial decisions on the underlying capital of the Trust to ensure continued financial security in the future. The collaboration between beneficiaries, Trustees, and professional advisors is crucial in achieving a sustainable and balanced approach to Trust management.

Trust Solicitors – Management of Trusts

At Burt Brill & Cardens we specialise in creating Trusts and managing Trusts and Trust funds and advising on Trust law. We represent beneficiaries, settlors and trustees in dealing with Trusts as well as providing legal advice and representation on all aspects of Trusts and their creation, management, and closure.

We will be happy to answer your queries on whether you should wind up your Trust, or if there are steps you can take to fix funds draining quickly. If you believe that your trustees are charging too much for their services, then read our article here: Disputing Trustee Charges. We also have more general information about Trusts available on our webpage, Setting up a Trust.

To speak to one of our expert Trust solicitors, ring us on 01273 604 123 or fill in our enquiry form.

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