Trust Funding Options

“Trust Funding Options,” that is the subject of today’s ACTEC Trust and Estate Talk.

This is ACTEC Fellow Julia Meister of Cincinnati, Ohio.

The choice of funding formulas can dramatically affect how trusts are funded and how the overall estate plan operates. Careful planning is especially important when dealing with hard-to-value assets, retirement accounts and other complexities that can influence how taxes are apportioned among beneficiaries.

ACTEC Fellow Stacy Singer of Chicago, Illinois will discuss trust funding options and the role they play in determining how assets are allocated within an estate plan. Welcome, Stacy.

Stacy Singer: Thanks, Julia. I’m really happy to be here to talk about one of those topics that many of us didn’t really dig into until we were in practice and really had to learn and understand the implications of different funding formulas. I want to dig into those formulas right now and talk a little bit about the different types of formulas and when one or the other might be beneficial.

Fractional vs. Pecuniary Bequests: The Two Core Funding Methods

So let’s start with the basics. There are two types of formulas that one can choose. Generally, those are a fractional bequest and a pecuniary bequest. And I’d like to start with the fractional bequest.

Understanding a Fractional Bequest Trust Funding Formula

Where you have a fractional bequest, it is not surprisingly described as a fraction. That is, a numerator and a denominator; I give one half to my children, I give a fractional share where the numerator is X and the denominator is Y. It’s normally pretty easy to tell that you have a fractional formula.

So, what are the characteristics of that kind of bequest? First of all, at least in theory, it means that each beneficiary is entitled to an undivided interest in each asset. It means that the assets are allocated proportionately among the shares and they don’t need to be revalued if that allocation is done proportionately.

It means that taxes, claims, debts, expenses, and especially appreciation or depreciation are shared proportionately between the different funded trusts. And if the assets are distributed in kind, there’s no capital gain.

Those are some very big advantages, particularly with respect to the capital gains issue. As we’ll talk about in a few minutes, a pecuniary bequest can in many cases lead to a gain on funding. This is especially important when you start thinking about things like IRA and 401k assets. If those assets are allocated using a fraction, there is no recognition of income at the time of funding.

When we think about the fraction, we’re going to apply that to the market value of the assets at the date of funding. That means you can’t really finalize the funding until after you have a closing letter, but you can absolutely do a partial funding and then do a true up once you have that closing letter. I will say I am a fan of fractional formulas as someone who’s worked at a corporate fiduciary and had to implement them, but there’s lots of debate on this topic.

What Is a Pecuniary Bequest Trust Funding Formula and How Does It Work?

So, what’s a pecuniary bequest? A pecuniary bequest is literally the gift of an actual dollar amount, and it can either be stated as an amount — I give $500,000 — or is part of a formula. So, you’ll often see things like I give to the trustee the smallest pecuniary amount that… and fill in the blank. That is not surprisingly a pecuniary formula.

So generally, a pecuniary formula means that the residuary taker either gets the upside or the downside through the funding date. If the assets go up in value, that residue is going to get more. But if they go down in value, that residue is going to get less. There’s a lot of flexibility in choosing which assets go into each trust. But as I mentioned before, if you fund with appreciated assets, you are going to incur capital gain.

And then perhaps most challenging in many cases, the assets that you use to satisfy the pecuniary bequest have to be valued at the date of funding. So that can lead to a lot of challenges, particularly if you have hard to value assets, assets that were valued with a discount on the estate tax return. Because first of all, you need to revalue them, that’s an additional cost; and secondly, that may actually not coordinate with what the family is thinking an asset is worth. Oftentimes, they love discounts for tax purposes, they don’t love them for distribution purposes.

Types of Pecuniary Formulas Explained: True Worth vs. Fairly Representative

Now, I think many of us just think pecuniary is pecuniary. But there are two types, and they have a very significant difference between them. The first is what’s known as true worth. And that’s also the one I think we think about the most often, although probably not the most advantageous. And here you’re going to satisfy the pecuniary amount using values at the date of distribution. That means that the pecuniary amount is a set amount, it does not get any upside or downside at all. And again, the residue does.

Now, as I mentioned before, that means that using things like IRD — think IRA assets or 401k assets — are going to have the recognition of income as soon as you fund. So be really careful, you do not want to use a true worth formula when you have IRA assets that are going to be passing through the formula.

The other type of pecuniary formula, and one that is I think more advantageous, is known as fairly representative. And that’s a gift that uses values as finally determined for federal estate or income tax purposes. But the catch here is that the assets allocated to that pecuniary share have to fairly represent the appreciation or the depreciation of the assets that are available. So, think everything has to somehow have the same up or downside. Now, that does not mean you have to allocate proportionate shares, although that can be the easiest. You can still pick and choose, try to get the assets you want outside of the pecuniary share outside. But you do have to make sure that overall the values in the pecuniary amount show the appreciation or depreciation since the date the funding was done.

The other thing I’ll just remind you is that assets that are allocated to that pecuniary share, again, have to be valued as of the date of distribution. And here it’s because you have to be able to show that you’ve fairly represented appreciation or depreciation, unless you use a pro-rata funding.

Choosing the Right Trust Funding Formula for Your Client

As you can see, these are very different results based on which of these different formulas that you choose. So, my suggestion is go back, look at your formula, make sure it makes sense, both as your default and for any particular client, because this is one of those areas that can trip you up simply because you haven’t looked at it recently.

Julia Meister:  Thank you, Stacy, for helping us understand how trust funding works.

 

You may also be interested in:

• Intersection of Family Law and Trusts and Estates (Dec 2024)
• Caution for Divorcing Spouses Who Are Trust Beneficiaries (Oct 2024)
• Spousal Support Provisions in Premarital Agreements (Jan 2022)

This podcast was produced by The American College of Trust and Estate Counsel, ACTEC. Listeners, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal or tax advice from their own counsel. The material in this podcast is for information purposes only and is not intended to and should not be treated as legal advice or tax advice. The views expressed are those of speakers as of the date noted and not necessarily those of ACTEC or any speaker’s employer or firm. The information, opinions, and recommendations presented in this Podcast are for general information only and any reliance on the information provided in this Podcast is done at your own risk. The entire contents and design of this Podcast, are the property of ACTEC, or used by ACTEC with permission, and are protected under U.S. and international copyright and trademark laws. Except as otherwise provided herein, users of this Podcast may save and use information contained in the Podcast only for personal or other non-commercial, educational purposes. No other use, including, without limitation, reproduction, retransmission or editing, of this Podcast may be made without the prior written permission of The American College of Trust and Estate Counsel. If you have ideas for a future ACTEC Trust & Estate Talk topic, please contact us at ACTECpodcast@ACTEC.org. © 2018 – 2026 The American College of Trust and Estate Counsel. All rights reserved.