As of January 1, 2002, a new law in New York State permits trustees to make adjustments between principal and income, and permits income to be computed using the 'unitrust' computation under new sections of the EPTL - the Estates, Powers and Trusts Law. Under the new Principal and Income Act, a trustee is now given the discretion to allocate the receipts of the trust between principal and income to balance the interests of current income beneficiaries and the remainder beneficiaries of the trust. The law applies to trusts in existence before January 1, 2002 unless the trust document directs otherwise.
The most common scenario for adjustment occurs when a trustee, investing for 'total return' under the Prudent Investor Act, earns capital gains at the expense of accounting income. The trustee, under the new Principal and Income Act, is authorized to make "fair and reasonable" adjustments between income and principal, to the extent the trustee deems advisable, to enable the trustee to make present and future distributions consistent with the overall investment strategy.
The Prudent Investor Act directs a trustee, unless otherwise specified in a trust document, to invest the assets of the trust as part of an overall investment strategy in accordance, in part, with the risk and return objectives reasonably suited to the entire portfolio. The 1995 law, which applies to all fiduciaries (executors, administrators, guardians, etc.) shifted the focus from whether a particular investment was prudent, to the overall process and strategy for investments.
Various factors in the new law provide guidelines for a trustee's discretionary allocation adjustment. For example, the donor's intent as stated in the trust, itself; the standards in the Prudent Investor Act; and the nature of the assets. These factors will be discussed in future articles.