Margaret M. Hand on Aspects of the Uniform Principal and Income Act in California Regarding Trust Accounting

Margaret M. Hand on Aspects of the Uniform Principal and Income Act in California Regarding Trust Accounting

California's adoption of the UPIA imposes on trustees the duty to invest and manage trust assets as would a prudent investor. Trustee are required to diversify trust investments, but may invest for total return following a modern portfolio theory. In this Analysis, Margaret M. Hand addresses the powers given trustees by the UPIA, including the power to make adjustments between income and principal and to account separately for a business or other activity. She writes:

     If the trustee invests for total return and, as a result, all or nearly all of the trust's receipts are receipts of principal, such "prudent" investments would favor the interests of the remainder beneficiaries over the interests of those beneficiaries entitled to income. Conversely, if the trustee prudently invests in investments that return trust accounting income but provide little capital appreciation, the income beneficiary is favored over the remaindermen. Yet trustees generally owe beneficiaries the duty of impartiality. The Uniform Principal and Income Act reminds the trustee that this duty is of particular importance when a trust's beneficiaries have conflicting interests in the trust's income and principal. Only if the trust instrument so provides may a trustee favor the interests of one beneficiary over another.

     PRACTICE NOTE: The settlor may express a preference for one or more beneficiaries in the provisions that govern the trust's distribution, in a separate provision describing the trust's purpose, or by implication. For example, if the deceased spouse has given the surviving spouse a testamentary limited power of appointment over the bypass trust and if by exercising that power, the surviving spouse might disinherit all or most of the remainder beneficiaries who would take in default of the exercise, the deceased spouse has impliedly favored the surviving spouse over all other beneficiaries.

     In isolation, the duties imposed by the UPIA could imperil the trustee's ability to discharge his or her duties of impartiality. The UPIA provides a remedy for this problem. When circumstances prevent a trustee from discharging his duty to treat income and principal beneficiaries impartially, if certain conditions are met, the UPIA allows the trustee to make adjustments between the trust's income and principal and thereby discharge the trustee's duty of impartiality.

[a] General Conditions Precedent to Making Adjustments

     The conditions under which the trustee may adjust between income and principal are as follows.

The power to adjust is only available to trustees who invest under the prudent investor rule;

The trust instrument must define one or more beneficiary's interests by reference to the trust's income;  and

The trustee determines, after applying the rules in subdivision (a) of Prob. Code § 16335, and considering any power the trustee may have under the trust to invade principal or accumulate income, that the trustee is unable to comply with subdivision (b) of Prob. Code § 16335.

(footnotes omitted)

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