The Federal Reserve is committed to keeping interest rates at record lows through 2015, but with the right strategy it’s still possible to increase savings and even income from trust accounts, according to John A. Pavela, vice president and senior portfolio manager at BMO Private Bank, and John W. Tinnemeyer, vice president, director and wealth advisor, BMO Private Bank.
“We’ve been on the downslide with interest rates for over a decade now, whether you look at the yield to maturity on U.S. Treasury notes and bonds, or on high-quality corporate bonds or tax-exempt municipal bonds,” says Tinnemeyer.
“During this period, yields ranged from 5.24% in December 2000, to a low of 1.39% in July 2012. As a result, overall disposable income has been impacted and those who want to maintain a quality lifestyle based on their savings and investments are wondering if that’s even a possibility,” he adds.
Trustees do have options to combat low rates, says Pavela. He recommends investors implement a balanced investment approach of stocks and bonds, with the goal of providing a reasonable level of income for the income beneficiary, as well as providing for principal growth for the remainder beneficiary.
While this might be impossible to alter if a portion of your assets is held in a trust for your benefit, there are options to explore if a primary financial component provides for the beneficiary’s lifestyle, and the income deficit must be met from somewhere else.
In cases where access to principal is permitted, this may result in additional requests being made by the income beneficiary to the trustee to distribute principal. These additional distributions may negatively impact the remainder beneficiary, especially if this low interest rate environment continues for an extended period of time.
An example of a balanced investment approach would be a $2 million trust invested 50% in a laddered portfolio of U.S. Treasury bonds with maturities between two and 10 years and 50% invested in the S&P 500 Index. At the end of December 2000, this hypothetical portfolio would have generated estimated annual income of $64,700 or 3.24%, with $52,600 coming from the bond portfolio and $12,100 from the stock portfolio.
Read: Trusts are essential to estate planning
The same type of portfolio would not look so attractive by today’s standards. As of the end of August 2012, it would hypothetically generate an estimated annual income of $27,440, or 1.37%.
“The income deficit must be met from somewhere else, if this trust was a primary financial component in providing for the beneficiary’s lifestyle,” Pavela notes. “This may result in additional requests being made by the income beneficiary to the trustee to distribute principal, in cases where access to principal is permitted. If this low interest rate environment continues for an extended period of time, these additional distributions may negatively impact the remainder beneficiary.”
According to Tinnemeyer, these issues can be combatted by the trustees. One option could be to explore additional types of investment strategies that could increase the level of income of the portfolio, including corporate, high-yield and international bonds, and focusing on dividend paying equities.
These strategies may increase risk, so the trustee will need to balance the level of risk with the expected return. Provided that state laws and the governing documents allow, another option is to convert to a unitrust, allowing the trustee to provide for a periodic distribution to the income beneficiary calculated as a percentage of the portfolio value, as opposed to being determined by the specific investments held inside the trust and the level of income being generated.
This “total return” unitrust allows the trustee to balance the objectives of both sets of beneficiaries without having to change the underlying documents.