Legislature(2003 - 2004)
05/05/2003 03:15 PM House JUD
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* first hearing in first committee of referral
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+ teleconferenced
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SB 87 - PRINCIPAL AND INCOME Number 0455 CHAIR McGUIRE announced that the next order of business would be SENATE BILL NO. 87, "An Act relating to principal and income in the administration of trusts and decedents' estates and the mental health trust fund; adopting a version of the Uniform Principal and Income Act; and providing for an effective date." Number 0511 BRIAN HOVE, Staff to Senator Ralph Seekins, Alaska State Legislature, on behalf of Senator Seekins, sponsor, paraphrased the sponsor statement, which read [original punctuation provided]: In 1984 the Alaska legislature adopted an early version of the Uniform Principal and Income Act (located in Statute 13.38). This Act provides rules for the determination of whether a trust's or estate's receipts should be considered income or principal. This distinction is often important because some beneficiaries may be entitled to income distributions, and others may be entitled to principal distributions. Senate Bill 87 updates the existing Statute to the most recent (1997) version of the Uniform Principal and Income Act. The drafters of the 1997 Uniform Act have recognized that there is a conflict between income and principal beneficiaries, and this conflict creates pressures on the fiduciary. The income beneficiaries want the fiduciary to invest so as to maximize annual income. The principal beneficiaries want the fiduciary to invest for long term equity growth. As a result, a trustee attempting to satisfy both sets of beneficiaries will have to compromise with respect to the choice of investments. Consequently, the total return of the trust will suffer. Two techniques have been adopted to avoid the need for such a compromise. These techniques allow the trustee to choose investment approaches which will maximize the total investment return of the trust. The first technique is provided by Article 1 of Senate Bill 87, which gives the trustee the discretionary power to adjust. This power allows the trustee to reallocate receipts from income to principal, or vice versa, when the trustee determines that it is fair and reasonable to do so. The second technique is provided by Article 2 which allows the trustee to convert a trust to a unitrust. This is a trust which provides that a certain percentage of its assets--often 4%-- will be distributed each year to the income beneficiary. Both of the above techniques will allow the trustee to choose investment approaches which will maximize the total return. As a result, both the income beneficiary and the principal beneficiary will receive greater distributions. Further, the trustee will not be struggling with the conflict in investment approaches. As of January 2003, thirty state have adopted the 1997 Uniform Principal and Income Act. Of these, twelve states have included the unitrust provisions. Senate Bill 87 follows the legislation enacted by Pennsylvania, which includes both techniques thereby enabling the trustee to maximize total returns. The State of Washington enacted this version in 2002. Georgia is presently considering it this year. MR. HOVE, in conclusion, urged passage of SB 87. Number 0730 REPRESENTATIVE SAMUELS moved to adopt the proposed committee substitute (CS) for SB 87, Version 23-LS0366\U, Bannister, 5/2/03, as the work draft. There being no objection, Version U was before the committee. CHAIR McGUIRE asked whether there are any other aspects of Version U that differ from the Uniform Principal and Income Act. MR. HOVE mentioned that Version U contains language specific to "our mental health trust fund." Number 0854 DAVID G. SHAFTEL, Attorney, noted that he and Stephen E. Greer are members of a group of trust and estate attorneys who have worked with legislative staff on SB 87. In addition to reiterating the points provided in the sponsor statement, he noted that Alaska's current laws on this issue are 40 years out of date, and that the changes provided in SB 87 are in keeping with modern-day business practices, investment concepts, and tax codes. He opined that the version of the Uniform Principal and Income Act which is before the committee is the most advantageous version. MR. SHAFTEL, in response to Chair McGuire's question, relayed that in addition to the unitrust provisions, which aren't part of the 1997 Uniform Principal and Income Act, Version U contains a provision - page 13, lines 5-9 - dealing with a recent Internal Revenue Service (IRS) regulation change that denies an income tax deduction for interest paid on pecuniary bequests. He explained: "What we have done is, we have repealed our interest statute, and instead we changed this [paragraph 2] so that pecuniary bequests receive a pro rata share of the income earned during the administration of an estate or a trust." MR. SHAFTEL, regarding other changes to the Uniform Principal and Income Act, said: We also have made it clear that this Act [applies] to revocable trusts as well as to estates. That is the intention of the drafters of the [Uniform Principal and Income Act] but several attorneys who've reviewed ... [it] have stated that they thought it would be advantageous to underscore that, so there has been language added which accomplishes that. We also have worked with the representatives of the [Alaska Mental Health Trust Authority] to put in language making this uniform Act inapplicable to the [Alaska Mental Health Trust Authority]; they want to handle principal and income allocations ... according to future regulations that will [be] adopted under that Act. MR. SHAFTEL, in conclusion, said that all members of the group that worked with legislative staff on this bill feel very strongly that Version U is an excellent version of the Uniform Principal and Income Act, and recommend that it be approved so that "Alaskan residents can have the benefits of these modern concepts." Number 1149 REPRESENTATIVE GARA asked, "If somebody has a trust agreement that ... specifically defines who gets the principal, who gets the income, and the agreement specifically defines principal and income, would the change in the definition in this Act change that existing agreement?" MR. SHAFTEL replied that that is an excellent question and [his group] hadn't addressed it. This Uniform Principal and Income Act, like all previous Uniform Principal and Income Acts, only provides default rules. Hence, if the creator of a trust decides that he/she wants different rules to apply regarding principal and income application, the rules in this Act can be overridden by so saying in the trust instrument. There are many types of allocations of principal and income, and to the extent that the creator of a trust does not provide specific rules for specific types of allocations, the default rules provided by SB 87 will apply if the need for those allocations arises during the administration of the trust or estate. REPRESENTATIVE GARA said he didn't want passage of SB 87 to disrupt any existing agreements. He asked whether SB 87 would apply retroactively to a trust in which allocation of principal and income has not been defined, thereby disrupting the expectations of an existing trust's beneficiaries. MR. SHAFTEL said that Senate Bill 87 will provide assistance to the administrator of an instrument that does not address the particular situations that arise when [income and principal allocation] is not covered in that instrument. Specifically, SB 87 will apply to the administration of trusts that are already in existence and [to] estates in the future that [rise] out of wills that are already in existence. But if the person who created that will or trust did not specifically address the particular principal and income allocation in question, then SB 87 will provide the answer, if needed, in the future. But again, if a trust or will already provides for a specific type of income and principal allocation, those provisions will override the defaults in SB 87. MR. SHAFTEL added that the rules outlined in the Uniform Principal and Income Act were arrived at by the National Conference of Commissioners on Uniform State Laws (NCCUSL); the NCCUSL has approved these rules and recommends them for enactment in all states. He mentioned that approximately 35 states have either adopted these rules or are considering their adoption. Number 1407 REPRESENTATIVE GARA replied: I still want to be very careful that we're not changing the amount of money that people are receiving in income and principal distributions .... I understand what you said, which is that agreements will provide the allocation between interest and income that somebody is entitled to as a beneficiary. But in paragraph one of the sponsor statement, it says here that we are also redefining the terms "income" and "principal" so that if somebody is entitled to income distributions, we're specifically defining what an income distribution is, and if somebody is entitled to principal distributions, we're specifically defining what a principal distribution is. And what I'm wondering is, if there are existing agreements out there where somebody is an income beneficiary or a principal beneficiary and they haven't defined those terms specifically, and if we're now redefining those terms a little bit, then are we going to start increasing or actually, for some people, decreasing the amount of money they're receiving under a trust? That's my big concern. MR. SHAFTEL said that while he understands the theory of the concern, he doesn't think it should be a realistic concern. He elaborated: I think that there are really several categories that we have to deal with. There are a number of general categories dealing with certain types of assets and the allocation of the proceeds of those assets between income and principal. Then there is another classification which is what we call a unitrust. ... And that is perhaps an area where, at least theoretically, Representative Gara's concerns would be more justified in that what happens there is, if you convert to a unitrust, what the Act provides is that instead of receiving the net income from a trust, the beneficiary will receive 4 percent of the assets of the trust. Number 1539 MR. SHAFTEL continued: But before there can be a conversion, the trustee has to notify all the beneficiaries. And if they object and feel that it would be unfair, then they're entitled to have the matter brought before the court and reviewed by the court as an abuse of discretion on the part of the [trustee]. But this (indisc.) of converting to a unitrust (indisc.) the concept of the power to adjust really are designed, not to reduce returns for income and principal beneficiaries, but rather to maximize the returns to both. And this is allowing the trustee to invest for a total return on all the assets, and then dividing up that total return between the income and the principal beneficiaries in a fair and reasonable manner. So, I really think the answer, Representative Gara, to your question is: that is a change in the law that hasn't existed before. It (indisc.) carefully thought out, and has a number of safeguards in the [proposed] statute by way of giving notice to the beneficiaries, allowing them to object, and allowing for judicial review. In most situations, the income and principal beneficiaries are going to be very happy to see that kind of approach taken by the trustee, because it's going to be a better return for both of them, rather than a mediocre compromise approach, which a trustee is [now] forced to take and which results in mediocre returns for both income and principal beneficiaries. Number 1629 MR. SHAFTEL went on to say: Now, the other aspect of your question, Representative Gara, would be ..., and this goes to that other category that we talked about, and that is, is there a particular kind of asset that a particular trust has that would result in a different allocation of income and principal under the '97 Act than under the ['62] Act, and would this disrupt the expectations of a person who created a trust and who was relying upon the '62 Act. And I guess that's conceivable. But ... there are a couple of things to consider there. [In the] first place, the person who created that trust evidentially didn't feel strongly enough about it to put in a particular allocation and override the '62 Act or confirm the '62 Act. And, if they did not do that, then what they're doing is - [the] people who draft these instruments ... - [they] are saying: "We are comfortable in adopting what state law is and will be, as considered by the National Conference of Commissioners on Uniform State Laws, who draft these Uniform Principal and Income Acts. And if the law is changed with respect to [an] allocation which we have not chosen to specifically override or reaffirm, then we are comfortable with what the [NCCUSL is] choosing." And I really think that is the best way to approach this problem. And it would be unfair to, for example, limit application of this Act to only trusts or estates drafted under documents executed after this date, because all of those settlors and all of those individuals who directed that their wills or trusts be drafted would not have the benefit of these modern updates that the [NCCUSL has] included in this '97 version of the Act. CHAIR McGUIRE indicated that it is important to have this kind of debate whenever updates to existing trusts are considered. Number 1811 PHIL YOUNKER, SR., Chair, Executive Committee, Board of Trustees, Alaska Mental Health Trust Authority ("The Trust"), asked whether the changes suggested by The Trust have been considered yet. MR. HOVE indicated that the changes recommended via an April 21, 2003, letter from The Trust's executive director, Jeff Jessee, have been incorporated into Version U of SB 87. MR. YOUNKER relayed that those changes will make a big difference in how The Trust is able to do business in the future. He thanked the committee for the opportunity to speak and the sponsor for bringing this issue forward and working with The Trust on its concerns. He said that as an individual, he is very pleased to see SB 87 because it is difficult to arrange, in the present time, for the future allocation of interest and principal of many of the assets that go into his personal trust. He concluded by encouraging passage of Version U. Number 1939 STEPHEN E. GREER, Attorney, said simply that he strongly urges passage of SB 87, that it has been long overdue, and that he is a bit embarrassed that Alaska's current principal and income Act is over 40 years old. CHAIR McGUIRE, after ascertaining that no one else wished to testify, closed public testimony on SB 87. The committee took an at-ease from 4:00 p.m. to 4:01 p.m. Number 2004 REPRESENTATIVE SAMUELS moved to report the proposed (CS) for SB 87, Version 23-LS0366\U, Bannister, 5/2/03, out of committee with individual recommendations and the accompanying zero fiscal note. There being no objection, HCS SB 87(JUD) was reported from the House Judiciary Standing Committee.
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