Fiduciaries handle an immense amount of duties and responsibilities related to the trusts they oversee. Arguably one of the most important responsibilities is complying with federal and state rules and regulations, like the Uniform Prudent Investor Act. This act was created to provide trustees with specific standards for managing investments within a trust. While UPIA is a fixture in the world of fiduciaries and trusts, it is often confused with the Uniform Principal and Income Act. So, how do these two acts differ and are fiduciaries responsible for complying with both? We discuss the most glaring differences and general concepts of both acts.
Key Act Differences
First, let’s clarify the difference between the Uniform Prudent Investor Act and the Uniform Principal and Income Act. While both Acts are uniform, meaning they sought to be implemented across various jurisdictions, and both center around trusts, the differences are stark. The Uniform Prudent Investor Act mainly focuses around investments, while the Uniform Principal and Income Act offers accounting guidelines specific to principal and income allocations.
The Uniform Prudent Investor Act
The Uniform Prudent Investor Act has been codified into law in 48 of the 50 states, as well as the District of Columbia and came in response to the 1959 Prudent Man Rule which opined that people who are in charge of other people’s money must handle it with the same care, skill, and caution as if the money was their own. Because the Prudent Man Rule was vague in terms of how they defined “care, skill, and caution”, the Uniform Prudent Investor Rule was issued in 1993 to fix the problem, along with a series of changes to the original guidance around investments. The Act itself was approved by the American Bar Association in 1995 and fiduciaries today must comply with its guidelines.
The Uniform Prudent Investor Act we know today focuses largely around the principles of risk, return, and diversification. It also requires trustees to take an active role in the ongoing review and adjustment of the investment strategies, including tax consequences, overall trust portfolio, total income return, and needs for liquidity. We cover an in-depth review of the UPIA and how to comply with its guidelines in our guide, Decoding the Uniform Prudent Investor Act.
The Uniform Principal and Income Act
Now, let’s get into the Uniform Principal and Income Act. This original Act was passed in 1931 before undergoing a series of modern-day revisions. Revisions were made in 1997 to align the trustee’s duty of distributing income with the çore concepts of the Uniform Prudent Investor Act.
Where the Uniform Principal and Income Act comes into play is when a trust assigns distributions according to the income generated within the trust. Trusts can have income beneficiaries and remainder beneficiaries, and it’s not uncommon for a trust to specify that beneficiaries, like a spouse or child, are entitled to the trust’s income for health, support, education, and maintenance – also known as HEMS.
As income beneficiaries receive income from the trust while alive, and remainder beneficiaries receive the corpus of the trust after the income beneficiary has passed away, this creates a challenge for the fiduciary in managing the potentially competing interests of both parties. Income beneficiaries may want the trust to be invested in income-related investments so they can receive as much income as possible. Remainder beneficiaries, on the other hand, prefer growth-oriented investments since that would increase the trust corpus.
Before the Uniform Prudent Investor Act was passed, trust investing focused on principal protection and income generation, which was a benefit to an income beneficiary, but a detriment to the remainder beneficiary. Over time society better understood the negative impact that inflation had on conservative investments such as bonds and CDs, and so the Uniform Prudent Investor Act was created to focus on total return.
Consequently, the Uniform Principal and Income Act needed to be modified because trustees now needed to know how to balance the concept of total return with the needs of the income beneficiaries. As long as the trust allows, the Uniform Principal and Income Act gives the trustee latitude to allocate principal to income as they see fit in order to fulfill the requirements of the trust’s distributions to the income beneficiary. The Uniform Principal and Income Act also provides a set of accounting rules for the trustee when allocating receipts and disbursements to principal and income. In other words, the Act gives power to the trustee to make adjustments to ensure the administration benefits the goal of the trust and its income and remainder beneficiaries.
Example of Principal and Income Allocation
When the Uniform Law Commission revised the Uniform Principal and Income Act they actually provided examples as to how the act might apply to trustees. One example they gave is of a successor trustee administering a trust that was written to provide income to person A for life, and the remainder corpus to person B after person A passes away. The successor trustee looks at the new portfolio of financial assets and sees that it’s invested 20% in stocks and 80% in bonds. The new trustee looks at the trust, the needs of both beneficiaries, and the requirements of the Uniform Prudent Investor Act and determines that a strategy of investing the portfolio 50% stocks and 50% bonds has risk and return objectives that are better suited to meet the trust’s objectives. However, the trustee also determines that adopting this approach will cause the trust to receive a smaller amount of dividend and interest income. So, he uses the authority given in the Uniform Principal and Income Act to transfer cash from principal to income to increase the amount available to be distributed to the income beneficiary.
Uniform Fiduciary Income and Principal Act
In 2018 the Act was updated and renamed the “Uniform Fiduciary Income and Principal Act, or UFIPA, to avoid confusion with the Uniform Prudent Investor Act and to differentiate itself from the previous iterations. Utah was the first state to adopt the Act, while states like California and Missouri have failed to pass it as of the 2022 legislative session. Among its provisions, UFIPA also addresses the duties of a fiduciary, judicial review of fiduciaries, and procedures for the termination of a trust.
UFIPA also gives power to convert the trust to a unitrust. A Unitrust, or sometimes referred to as a “Total Return Trust”, gives the option to beneficiaries to receive a set percentage of the net asset value of the trust on a monthly or yearly basis, typically around 4%. This is in contrast to a standard irrevocable trust which provides beneficiaries with an income, which can fluctuate in value depending on investments and economic conditions.
It’s clear. Even though both Acts at one point shared the same abbreviation, they could not be more different in concept. Still, trustees are responsible for complying with both Acts, so it is utterly important that the trustee is familiar with its guidelines.
For trustees who are looking to remain compliant with the rules and regulations of the UPIA, Prudent Investors can help you navigate all aspects of trustee investing. We work closely with professional fiduciaries and family trustees to build an investment strategy that benefits the trust, while also reduces trustee liability. Connect with our team to learn more about our investment management service.
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