How long may the income from a trust be accumulated and in what circumstances may that income be distributed?
Accumulation and maintenance trusts
Since the beginning of equity, when the “length of the Lord Chancellor’s foot” determined the outcome of cases, trusts have been employed as tax devices. From time to time, the Chancellor of the Exchequer rules out certain forms of trusts as tax havens, eg discretionary trusts — a popular mechanism for tax saving — have been recently ruled out. However, for the time being, accumulation and maintenance trusts (so long as the settlor is not the father of the beneficiary) remain advantageous from the fiscal point of view.
A trust may be established where the income is not required to be distributed each year. Instead, it may be accumulated. This is a useful way of providing a lump sum for a beneficiary at a later date. There are, however, statutory provisions which restrict the power to accumulate. A settlor may not accumulate income or keep property tied up in a trust forever. This rule was first established after the famous case of Thellusson v Woodford (1799) 4 Ves 227. Peter Thellusson, a man of great wealth, wrote a will under which his huge fortune was to be accumulated for 80 years, by which time it would have been worth £100m. At that time there was nothing to prevent such an accumulation. (In fact, the estate was eaten up by litigation and mismanagement, and when it was distributed in 1856, very little was left.)
Accumulation period
Statute now provides various maximum permitted periods during which income under a trust may be accumulated. There are two periods to bear in mind: the accumulation period and the perpetuity (or trust) period.
In the first place, the income may not be accumulated for a period longer than a life in being plus 21 years. This is the common law period of perpetuity. If it is exceeded no income can be accumulated at all. It must all be distributed.
Provided this requirement is satisfied, then the second question is to establish the period of accumulation. The settlor has a free choice as to which period to select. The Perpetuities and Accumulations Act 1964, section 13, and the Law of Property Act 1925, sections 164-6, together provide a choice of six periods. The settlor must select one of these. They are:
(a) the life of the settlor;
(b) 21 years from the date of the deed;
(c) 21 years from the death of the settlor;
(d) the minority or minorities of any person(s) living or en ventre sa mere (“in the womb of its mother”) at the death of the settlor;
(e) the minority or minorities of any person(s) who, under the instrument directing the accumulation, would, if of full age, be entitled to the income directed to be accumulated;
(f) the minority or minorities of any person(s) in being at the date of the deed.
Once the accumulation period is over, the income must be distributed. However, a settlor may wish, at the end of this period, for the income to be distributed at the discretion of the trustees. This enables the trustees to have some flexibility as to the manner in which they distribute the income. If the period of accumulation exceeds the statutory period, but falls within the perpetuity period, then the direction to accumulate will be void only during the time in which it overruns.
The trust need not come to an end when the accumulation period closes. Even so, a private trust may not endure forever. The difference between the accumulation and perpetuity periods is that, with the former, it merely limits the length of time during which the income may be accumulated; when the perpetuity period expires however, the trust is over. The remaining capital must be distributed.
Perpetuity period
There are various perpetuity periods permitted by statute. The most convenient and modern is a period not exceeding 80 years: Perpetuities and Accumulations Act 1964. All the gifts would, therefore, have to vest within 80 years.
When a gift is made to a class of people, for example, “all the grandchildren of the settlor”, then each gift must vest within the perpetuity period. Where the gift is to all future grandchildren who reach the age of 25 (an age frequently selected for tax purposes), then there will be a risk that a grandchild could be born who will reach 25 after the perpetuity period has elapsed. This would cause the gift to fail. A properly drafted trust, deed or will should deal with this danger. If the trust fails to deal with this point there are rules which will artificially close the class, provided that there is nothing in the trust which will prevent them from operating: Andrews v Partington (1791) 3 Bro CC 401. These rules are designed to make the trust easier to administer. The trustees know what share of the capital they may distribute as soon as the first person satisfies the conditions of the gift. The effect of these rules may also prevent the gift failing for perpetuity.
The disadvantage of this is that it may exclude later-born grandchildren. This is outweighed where the alternative is an invalid gift. It also means that the trustees will know how much to distribute to the first beneficiary who reaches the vesting age because, at that point, the shares will be fixed.
Many of the general powers required by a trustee to administer a trust are contained in statute: Trustee Act 1925. So, a trustee may sell land by auction, give receipts, insure property, employ agents or raise money by sale (or mortgage), without these powers being spelt out in the trust. However, these powers may be expressly extended or restricted in the trust deed in order to meet the requirements of the particular settlor.
Power of maintenance
Statute contains the power for a trustee to provide intermediate income for the maintenance, education or benefit of a minor: section 31 of the Trustee Act 1925. But this power, although apparently wide in its scope, is limited in that a trustee must take account of the age, requirements and circumstances of the child. However, the income can be used in this way even if there is someone who is legally bound to provide for the child, such as a parent, or some other fund is available for his support.
It may therefore be desirable expressly to extend the power of trustees to give them absolute discretion to make income available for these purposes, particularly where this is one of the primary objects of the trust.
The object of the power of maintenance is to provide for a minor beneficiary who is not yet entitled to income or capital. It can be used to pay for education or for the basic needs of living. It is available where the gift carries intermediate income. The power ceases when the child reaches the age of majority, when the income must be paid direct to the child, provided the gift has vested. Any income not used for maintenance may be accumulated by way of compound interest. If the child has a contingent interest, for example, contingent on reaching the age of 25, then the income must be added to capital unless the settlor specifies otherwise.
Power of maintenance
Statute contains the power for a trustee to provide intermediate income for the maintenance, education or benefit of a minor: section 31 of the Trustee Act 1925. But this power, although apparently wide in its scope, is limited in sidered to be very inconvenient. They require the trust fund to be divided in a complicated manner and require a higher proportion of the fund to be kept in gilt-edge securities than many professional advisers consider desirable.
If a settlor wishes the trustees to have power to make loans (or to authorise purchases) which are not “investments” in the narrow, legal sense, then this needs to be provided for expressly in the trust, deed or will. For example, the purchase of a house and furniture for a beneficiary to live in and enjoy may not be considered an “investment” under the statute. Without express permission in the deed, it might not be permitted.
Duties of trustees
While such wide powers may give the trustees apparently unfettered discretion, nevertheless, there remains an overriding obligation for them to act honestly. If there is an improper exercise of their discretion, then, however wide the maintenance clause, investment clause or any other clause may be, the court will retain a residual power to intervene at the behest of a beneficiary. Therefore, the trustees must always act prudently and with the objects of the trust in mind. There is a very strict rule that trustees may not profit from a trust since this would be in conflict with the high fiduciary duty which they owe the beneficiaries.
The role of the trustees is critical and it is not without good reason that a high standard of fiduciary care is imposed upon them. A settlor may choose to rely simply on the statutory powers. Alternatively, wider discretions may be given to trustees. While a settlor may retain a degree of control over a trust by the use of a “deed of wishes”, none the less the selection of the trustees is of considerable importance.
