Lumpsum Payouts from Testamentary Trusts: Balancing Equity and Practicality

A testamentary trust is a type of trust that is created according to the instructions in a deceased person’s will and comes into effect upon their death. One of the key considerations in setting up such trusts is how to structure lumpsum distribution of funds to the beneficiaries.

Typically, lumpsum distributions are either a fixed sum or a percentage of the remaining trust fund balance, rather than a percentage of the original trust fund value. If the objective is to provide equal monetary distributions to both sons, a fixed sum payout system might be more appropriate. This approach provides more predictability and fairness, notwithstanding any special circumstances such as medical emergencies.

By default, lumpsum % in getArrange platform is based on "Balance of Trust Fund".

This distinction is crucial because the value of the trust fund can fluctuate significantly over time due to various factors, including additional income, expenses, and special withdrawals for things like medical expenses for the beneficiaries. Let's take a look at the two examples as comparisons.

Negative Example

To illustrate the complexities involved, consider a settlor who established a trust in 2020 for his two sons, aged 8 and 5. The settlor might initially think it’s straightforward to allocate the trust fund such that each child receives 25% of the trust fund when they reach age 15 and another 25% when they reach age 21. i.e.

Son 1 gets 25% of the trust fund at age 15 in 2027.
Son 2 gets 25% of the trust fund at age 15 in 2030.
Son 1 gets 25% of the trust fund at age 21 in 2033.
Son 2 gets 25% of the trust fund at age 21 in 2036.

On the surface, this approach might seem fair, but a closer examination reveals potential inequities.

Assume the trust fund starts with a principal of $100,000. Under the initial plan:

Son 1 gets 25% at age 15 in 2027, which is $25,000.
Son 2 gets 25% at age 15 in 2030. Assuming the fund has $75,000 remaining (without considering income, expenses, or withdrawals), Son 2 would receive $18,750.

This pattern continues, leading to disparities in the actual amounts each child receives due to the decreasing fund balance.

Alternatively, even if percentages were recalculated based on the remaining balance:

Son 1 gets 25% of the remaining balance at age 15 in 2027.
Son 2 gets 33% of the remaining balance at age 15 in 2030.
Son 1 gets 50% of the remaining balance at age 21 in 2033.
Son 2 gets 100% of the remaining balance at age 21 in 2036.

this approach does not ensure equal monetary amounts due to the fluctuations in the trust fund's value (e.g. due to additional interest from interest rates earned, or expenses)

Positive Example

Presuming the same initial $100,000 in the trust fund, here's an alternative distribution plan (which in addition caters to some buffer):

Son 1 receives $20,000 at age 15 in 2027.
Son 2 receives $20,000 at age 15 in 2030.
Son 1 receives $20,000 at age 21 in 2033.
Son 2 receives $20,000 at age 21 in 2036.

Remainder Beneficiaries

Upon the termination of the trust, when Son 2 reaches age 21, any remaining balance of the trust fund can be equally divided between the two sons:

50% to Son 1
50% to Son 2

This method ensures that both beneficiaries receive equal lump sums at predetermined ages, while also sharing the remainder of the trust fund equally. It also accounts for any unforeseen expenses or income fluctuations by using fixed sums, providing a buffer for contingencies.

In conclusion, structuring lumpsum payouts from a testamentary trust requires careful consideration of the trust's value fluctuations over time and the beneficiaries' needs. A fixed sum distribution method can offer a practical and equitable solution, ensuring fairness and predictability in payouts while accommodating the potential for unexpected financial needs.