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Will & Trust Product Summary: Demystifying Trust Beneficiaries and Distributions

Review Trust summaries with confidence and clarity, presenting the opportunity for earnest evaluation of the client's intentions.

Living Trusts and Wills are revocable legal arrangements that can be modified or revoked, allowing for adjustments as a client’s circumstances change. 

Analyzing beneficial interests and distribution language can empower clients to discuss potential changes with their estate planning attorney, where appropriate.

Holistiplan's Estate Planning product reviews:

The summarization of Wills, Living Trusts, and any trusts that may be created thereunder (referred to herein as “Resulting Trusts”) presents an opportunity for advisors to add value during estate planning reviews. 

Beneficiary Ordering and Interest

Holistiplan’s estate logic assigns a beneficiary order to each identifiable beneficiary or class of beneficiaries within the resulting trust.

Each beneficiary or class is also assigned an interest type:

  • Income – Refers to the trust’s income portfolio. Income is a fiduciary accounting concept and is not synonymous with taxable income. The trustee assigns receipts and disbursements to the income portfolio based on the trust’s terms or, if not specified, in accordance with applicable state principal and income accounting rules.

  • Principal – Refers to the trust’s principal portfolio. Principal is a fiduciary accounting concept and is not equivalent to tax basis. The trustee allocates receipts and disbursements to the principal portfolio as directed by the trust’s terms, or—if unspecified—by relevant state accounting rules.

  • Other – Represents an interest not tied to fiduciary accounting income or principal. Instead, it is calculated based on the total account value—such as a percentage, annuity, or fixed dollar amount.

  • Remainder – Represents an interest in the trust’s remaining value upon termination.

Takeaway 1

Beneficiary distributions are first limited by the availability of income or principal (receipts minus disbursements), before the trust’s distribution standard is applied.

 

Distribution Standards

Holistiplan’s estate logic also assesses the trust’s distribution standards, which typically range along a spectrum from narrow to broad in scope:

  • Mandatory Income – Distributions are required and not subject to the trustee’s discretion. However, the distributed amount will be net of fiduciary income accounting debits (e.g., trustee fees).

  • Discretionary Income/Principal Pursuant to an Ascertainable Standard – Distributions are discretionary but must adhere to a defined, ascertainable standard, often based on language from the Internal Revenue Code. Common justifications include health, education, maintenance, and support (HEMS), or any combination thereof. Since the scope of allowable expenses under HEMS is not uniform, and in the absence of specific trust language, application may be guided by court interpretations and the trustee’s internal policies—often implemented by a discretionary distribution committee, especially in the case of a corporate trustee.

  • Discretionary Income/Principal Pursuant to a Custom Standard – The distribution standard either falls outside the bounds of HEMS or includes additional customizations such as “comfort,” “happiness,” or “reasonable luxuries.” These custom standards typically reflect the grantor’s intent regarding the lifestyle and types of expenditures allowed for beneficiaries. Clients may benefit from discussing with their attorney and trustee opportunities to provide further clarification through guiding language (often referred to as a letter of wishes or precatory language).

  • Discretionary Income/Principal Pursuant to a Broad Standard – The distribution standard is broad and usually includes language such as “total discretion,” “absolute discretion,” or “for any reason or purpose.”

Takeaway 2

Distribution standards exist along a spectrum of options. While the client’s intention is paramount, allowable expense types remain subject to interpretation. Additionally, distributions are limited by the availability of income or principal within the trust, based on the beneficiary’s assigned interest.

 

Other Interest Distribution Standards

Our estate logic assesses distribution standards for Other interests—those not explicitly tied to the trust’s income or principal portfolios. These interests may be expressed through:

  • A percentage of the trust

  • An annuity payment

  • A periodic lump-sum cash amount, which may or may not be adjusted, or

  • A one-time lump-sum cash amount

 

 

Takeaway 3 

Distributions may be determined through a calculation method or a specified amount, with the trustee administering the distribution in accordance with the trust’s language. Clients should consider both the clarity of these provisions and the administrative feasibility for the trustee.

Key considerations include whether the trust specifies valuation dates and whether distributable amounts are adjustable. These adjustments can help preserve the beneficiary’s purchasing power through inflation indexing or help protect the trust corpus from erosion in down markets.

 

Rights of Withdrawal

Holistiplan’s estate logic assesses distribution standards for Rights of Withdrawal, a provision that allows beneficiaries to access trust assets directly, without requiring trustee discretion.

Commonly referred to as a “5 by 5 Power,” this clause permits a beneficiary to withdraw the greater of $5,000 or 5% of the trust’s fair market value annually. It is often included to provide beneficiaries with limited, predictable access to trust funds.


Example:

  • If the trust holds $50,000, 5% equals $2,500. The beneficiary may withdraw $5,000.

  • If the trust holds $200,000, 5% equals $10,000. The beneficiary may withdraw up to $10,000, as it exceeds the $5,000 floor.

Perceived Benefits:

  • Balances Flexibility and Trust Preservation – Grants beneficiaries access to additional funds without relying on trustee discretion, while capping the withdrawal amount to preserve the trust’s principal.

  • Predictable – Offers beneficiaries a level of financial certainty that can aid in personal financial planning.

  • Tax Advantage – Withdrawn amounts are typically included in the beneficiary’s taxable income, not the trust’s, which can offer strategic tax planning opportunities.

Perceived Drawbacks:

  • Distributions May Outpace Growth – If trust investments underperform, annual withdrawals can erode the principal over time.

  • Increased Tax Liability – Since distributions are taxed as the beneficiary’s income, they may lead to a higher personal tax burden.

     

Takeaway 4

Rights of Withdrawal are not subject to trustee discretion and are typically customized by the trust creator. They are generally drafted as a 5% (or lower) annual limit to provide a balance between beneficiary access and long-term trust preservation. When deciding whether to include such a provision, clients should weigh the perceived benefits against potential drawbacks, including tax implications and impact on trust longevity.