How to deal with income and capital beneficiaries

One of an executor’s central duties is to maximize estate income and distribute that income (along with other estate assets) to beneficiaries as noted in the will.

But what happens when an estate’s income and capital go to different people? How does an executor serve both groups of beneficiaries when their respective interests are mutually exclusive?

Conflicting interests

As Joseph Gyverson, estate lawyer at Gyverson Law Group in Toronto, explains, having distinct income and capital beneficiaries is a fairly common scenario in so-called “blended” families, which have children from previous relationships.

In such cases, a testator often wishes to provide income for a spouse (typically via a testamentary trust) while ensuring children from a prior marriage receive the remainder of estate assets when the spouse dies.

“Usually the trust that generates that income will last for the duration of the beneficiary’s life—which could be decades,” Gyverson says. “The capital beneficiaries don’t get anything from the estate until the trust beneficiary has passed away.”

The conflicting interests of income and capital beneficiaries create challenges for the executor, particularly if the will gives the executor discretion to draw upon capital to provide further income from the estate.

“The income beneficiary might say, ‘I need more money; this income’s not enough,’ and they want the capital to be invested in a certain way that generates more income,” he says.

That often requires riskier investments, which could leave the estate’s capital diminished and make it difficult to achieve a balance between the needs of income and capital beneficiaries, he says.

Nevertheless, the will may give priority to income beneficiaries. The executor would have to look at the income beneficiary’s circumstances to see if the needs are reasonable, Gyverson says.

“If the will is written in such a way that the first priority is to ensure the income beneficiary is taken care of, and that there’s discretion to draw upon capital to do this, then the executor’s first responsibility is to ensure that the needs of that person are reasonably met.”

An even hand

If the will doesn’t prioritize one set of beneficiaries over the other, executors must maintain an even hand, says Michael Klaray, partner with Duncan Craig LLP in Edmonton.

The “even-hand rule” requires a trustee to balance each beneficiary’s interests: to generate income for the income beneficiary, including interest and dividends, while ensuring that the trust fund’s real capital value (adjusted for inflation) is at least preserved for the capital beneficiary.

Achieving a balance between these two groups can be challenging, since their interests “are almost always at odds with each other,” Klaray says.

How should an executor resolve such issues? Klaray suggests seeking professional advice for protection in the event of a lawsuit. Another option is to ask the court for advice and direction via a short chambers hearing, which “essentially blesses the activity you’re about to do.”

In Alberta, Klaray estimates a regular chambers hearing might take between eight and 12 months to schedule, and might cost between $3,000 and $5,000 in legal fees. But, he says, the investment is worth it.

“So long as the executor hasn’t misled the court and has been totally transparent, then the beneficiaries can’t at a later date come back and complain about that action.”

Quick tips: estates with income and capital beneficiaries

Maintain an even hand

The “even-hand rule” requires executors to be fair and impartial when dealing with both income and capital beneficiaries. Failure to do so could expose the executor to personal liability.

Think about risk

Risky investments that might benefit the income beneficiary may end up being detrimental to capital beneficiaries, or vice versa.

Keep good records

This is always good advice, but it’s particularly important when an executor may have to pass accounts or prove they haven’t improperly favoured one beneficiary over another.

Re-evaluate and revise

Executors should re-evaluate both the circumstances of income beneficiaries and the investment rationale for trust assets in order to ensure they haven’t tipped the balance toward one side.