Interest on Pecuniary Devises: Mountain Out of a Molehill?

Weighing the increasing conflicts between will-based plans, and revocable trust-based plans, that provide for pecuniary bequests

Pecuniary bequests and devises in an estate plan (in other words, distributions of a set dollar amount as opposed to a percent) can create a variety of tax and administrative issues. For illiquid estates, there may be a tax drag if there is not sufficient cash to pay estate, death, and inheritance taxes prior to satisfaction of pecuniary gifts. Distribution of assets in-kind (i.e., non-cash distributions) in satisfaction of a pecuniary gift may be limited or prohibited by the governing instrument or local law, and in some cases may trigger recognition of gain (or income in respect of a decedent) by the estate or trust.

Even when a distribution of a pecuniary amount is not required under an instrument, formulas for dividing trusts which are based on a pecuniary amount can raise issues. The funding of a marital trust or credit shelter trust determined by a pecuniary amount (such as the classic “smallest amount that can be distributed so as to reduce the federal estate tax to zero taking into account the marital deduction, charitable deduction, and/or credit or deduction for state death and inheritance taxes”) can trigger the same gain and IRD recognition issues described above, except in some cases where fractional funding or fairly representative funding is used. In the case of GST tax funding formulas, a division or qualified severance may require fractional funding or fairly representative funding, as well as interest accrual from the last valuation date on the pecuniary amount.

While the tax issues are a bit outside of the scope of this article, there is a growing divide between the state law treatment of pecuniary gifts from the perspective of administering trusts and estates. This divide often revolves around two questions. One, does a pecuniary gift accrue interest if distribution is delayed too long? Two, does a pecuniary gift carry out income that has accrued within the estate or trust? In this Article, I am going to pick on my home state of Colorado in addressing the former question while highlighting a common change taking place in many states - the shift from the Uniform Principal and Income Act (UPIA) to the Uniform Fiduciary Income and Principal Act (UFIPA).

UPC Treatment

The Uniform Probate Code (2019 being the most recent version), which has been adopted in some form by approximately 18 states as of the date of this article, has specific provisions addressing pecuniary bequests or devises under a will. In particular, UPC Section 3-904 provides:

General pecuniary devises bear interest at the legal rate beginning one year after the first appointment of a personal representative until payment, unless a contrary intent is indicated by the will.

Building on this concept, both the elective-share amount and supplemental elective-share amount are treated as general pecuniary devises for purposes of this interest accrual requirement under UPC Section 2-209(e). Colorado has adopted both of these principles, with one refinement - namely, that the elective-share interest only starts to accrue one year after determination by the court. (Note that this interest accrual is not expressly applied to, or referred to by, the intestate distribution schemes which may use pecuniary dollar amounts).

These principles are well-settled in the case of an estate plan that is governed primarily by a will, but it is increasingly more popular to use an estate plan that is governed primarily by a revocable trust. What happens in such a case, where the pecuniary gift comes from revocable trust assets or where an elective-share must be satisfied from revocable trust assets? More particularly, can you completely avoid this possibility of interest accrual simply by using a revocable trust?

UPIA Approach

Some states have adopted the Uniform Trust Code (UTC) as a companion to the UPC, and the UTC generally incorporates the same rules of construction that are applicable to wills. (See UTC Section 112). However, the interest rule may be more of a rule of administration, so it is not clear whether this can create a back-door to apply the interest accrual rule to a revocable trust.

However, we can address this issue without turning to the UTC. Many states have also adopted the Revised Uniform Principal and Income Act (UPIA). The last sentence of UPIA Section 201(3) provides:

If a beneficiary is to receive a pecuniary amount outright from a trust after an income interest ends and no interest or other amount is provided for by the terms of the trust or applicable law, the fiduciary shall distribute the interest or other amount to which the beneficiary would be entitled under applicable law if the pecuniary amount were required to be paid under a will.

So, for those states which still use the UPIA, this part of Section 201 (if retained) makes the rules for trusts consistent with the rules for wills.

While Colorado has since replaced the UPIA with the UFIPA effective January 1, 2022 (discussed below), the prior version of the UPIA retained this provision creating consistency with the UPC. In fact, this was intentional, as evidenced by Colorado’s prefatory notes to the UPIA which state:

New rules. Issues addressed by some of the more significant new rules include:

1. The application of the probate administration rules to revocable living trusts after the settlor's death and to other terminating trusts. Sections 15-1-406 through 15-1-410.

2. The payment of interest or some other amount on the delayed payment of an outright pecuniary gift that is made pursuant to a trust agreement instead of a will when the agreement or state law does not provide for such a payment. Section 15-1-406(1)(c).

This brings us now to the 2018 revision to the UPIA, which adopted a new name - the Uniform Fiduciary Income and Principal Act. The UFIPA contains an optional, stand-alone provision which is intended for states which do not directly address the accrual of interest for a pecuniary distribution under an inter vivos trust. This optional provision, UFIPA Section 601(e), states:

If a beneficiary is to receive a pecuniary amount outright from a trust after an income interest ends because of an income beneficiary’s death, and no payment of interest or the equivalent of interest is provided for by the terms of the trust or applicable law, the fiduciary shall pay the interest or the equivalent of interest to which the beneficiary would be entitled under applicable law if the pecuniary amount were required to be paid under a will.

As noted in the comments to Section 601:

This provision is intended to accord gifts under inter vivos instruments the same treatment as testamentary gifts.

Interestingly, when Colorado shifted from the UPIA to the UFIPA, this provision was not retained. In addition, the comments and prefatory language previously incorporated into Colorado’s UPIA were not included here. Which begs the question - why, when there was a prior “legislative intent” to treat pecuniary gifts under wills and inter vivos trusts the same under the UPIA did this intent not carry over to the UFIPA?

Not to pick on the Trusts & Estates Section of the Colorado Bar Association too much, but in the notes of the Statutory Revisions Committee when discussing the UFIPA on October 7, 2020, we find:

The subcommittee does not recommend enactment of Section 601(e), which required a fiduciary to pay interest on a pecuniary amount after an income interest ended (similar to the interest a beneficiary would receive if the pecuniary amount were paid under a will). The subcommittee was concerned that this may result in unintended windfalls, especially if the delay in paying the pecuniary amount was not the result of fiduciary action or inaction (i.e. waiting on a court or administrative agency to make a determination).

Take that as you will. It essentially means the statutory accrual of interest can be avoided as a matter of law simply by using a revocable trust. It also calls into question whether statutory interest can accrue on the elective-share, if the elective-share is payable from trust assets.

What Other States are Doing

So far, the UFIPA has also been adopted by Arkansas, California, Kansas, Utah, Virginia, and Washington. All six of these states have retained the language requiring consistent treatment of interest accrual between a will and a trust for pecuniary gifts where the law is otherwise silent regarding trusts.

UPIA Disparities

For the sake and scope of this article, I have not yet dug into a state-by-state comparison of the UPIA treatment of pecuniary gifts between wills and trusts. But, stay tuned for more.

GST Tax

A hidden issue with this disparity in any state can be found in one of my areas of affinity - the GST tax. While I have a broader article on this issue coming down the pike, it is important to note that a pecuniary distribution from trust as a result of a settlor’s death may not be a separate and independent share of a trust if interest does not accrue at least at statutory rate applicable to wills/trusts mentioned above, or if greater, 120% of the 7520 rate at settlor’s death. However, this interest accrual is deemed to be satisfied if the distribution is made or irrevocably set aside within 15 months of the settlor’s death. (See Treas. Reg. 26.2642-2(b)(4) and 26.2654-1(a)(ii)).

Key Takeaways

The principles cited herein are all statutory defaults applicable where a will or inter vivos trust is silent. The Uniform law provisions all create an option whereby the will or trust can mandate interest at a different rate, or can waive the accrual of interest on pecuniary distributions. However, the GST tax provisions do not allow such a waiver.

I bring these points up to shine light not just on the drafting process, but also the legislative review process of adopting Uniform acts. Sometimes, simple bar committee provisions can have unanticipated or unintended changes that create significant issues.