When the Power to Adjust Applies
Modern investment strategy often prioritizes total return. This blends growth and income. But many older trusts were written when investments generated more predictable income streams like bond interest and stock dividends. When the terms of the trust say "distribute the income," a trustee investing for total return might generate less traditional income but more capital appreciation. This statute under the principal and income act gives the trustee a tool to fix that imbalance.
A trustee may adjust between principal and income to the extent the trustee considers necessary if the trustee invests and manages trust assets as a prudent investor, the terms of the trust describe the amount that may or must be distributed to a beneficiary by referring to the trust's income and the trustee determines, after applying the provisions of section 14-7402, subsection A, that the trustee is unable to comply with section 14-7402, subsection B.
A.R.S. § 14-7403(A)The trustee must consider several factors before making an adjustment. These include the nature and purpose of the trust, the settlor's intent, and the beneficiaries' circumstances. The need for liquidity versus capital preservation also plays a role. Tax consequences, economic conditions, and inflation all factor into the decision.
Important Restrictions on the Power
This authority is not unlimited. The statute lists several situations where the trustee cannot exercise the power to adjust. For example, the trustee cannot reduce income in a trust that qualifies for an estate or gift tax marital deduction. The trustee also cannot change fixed annuity or unitrust amounts. Funds permanently set aside for charity cannot be redirected.
There are also conflict-of-interest safeguards. A trustee who is also a beneficiary cannot use this power. Neither can a trustee whose adjustment would benefit them directly or indirectly. If one trustee is disqualified, a co-trustee without the conflict can still make the adjustment. This applies as long as the trust allows it.
The trustee can also release this power entirely. This can be permanent or for a specific period. Releasing the power makes sense when holding it would create tax problems or when a trust might be converted to a unitrust instead. This flexibility ensures the power to adjust between principal and income helps rather than harms the trust's overall structure. When amounts are distributed to a beneficiary under this power, the trustee should document the reasoning carefully.