FWR: There are lots of different types of trusts. From the main forms used by affluent/high net worth US citizens, which ones tend to be more useful when rates are falling/rising, and why?
Stein: There are two important considerations – the impact of interest rates on trust distributions once a trust has been set up, and the way interest rates affect the estate planning benefits of setting up a trust.

Flexible trusts tend to outperform rigid ones in both rising and falling interest rate environments. For example, unitrusts and discretionary trusts allow trustees to adjust distributions based on market conditions and beneficiary needs. In contrast, trusts that rely solely on income – like traditional income-only trusts – can suffer when rates fall, as bond yields and other fixed-income returns shrink. 

Interest rates play a pivotal role in the effectiveness of various estate planning trusts. GRATs perform best in low-interest rate environments, as the IRS hurdle rate is easier to outperform, allowing more tax-free wealth transfer to beneficiaries. IDITs benefit from low Applicable Federal Rates, which reduce the interest burden on promissory notes used in sales to the trust, enhancing long-term growth outside the estate. QPRTs , on the other hand, are more favorable when rates are high, as the value of the retained interest increases, lowering the taxable gift.

Charitable trusts like CRUTs and CLATs are also rate-sensitive – low rates reduce the donor’s tax deduction in CRUTs but enhance the efficiency of CLATs by increasing the present value of charitable annuity payments, making timing and structure critical to maximizing impact.

FWR: Can you explain the mechanics – looking at a couple of different trusts – of how interest rate changes affect the trusts and their beneficiaries?
Stein: Take a simple income-only trust: when rates fall, the income generated drops, which can reduce distributions to beneficiaries. In addition, interest rate changes can make the price of bonds volatile. As interest rates decline, the price of bonds goes up, and when rates rise, it has an inverse relationship on the price of fixed income. If bonds are not held to maturity, these adjustments could affect the portfolio. 

Conversely, a unitrust – where beneficiaries receive a fixed percentage of the trust’s value – adjusts with the entire portfolio’s market performance, offering more alignment with the overall performance of the trust. Another example is a charitable remainder trust : lower rates reduce the present value of the charitable remainder, which can affect the donor’s tax deduction and the trust’s long-term viability.      

FWR: What are people telling you about the interest rate angle? Are they aware of the rate impact, or do you tend to raise the topic? Is there a lack of awareness on the matter?
Stein: There is growing awareness, but it’s still uneven. Many clients focus on the tax or control aspects of trusts and overlook how economic conditions, especially interest rates, can shape outcomes. We often raise the topic proactively, especially when reviewing older trust documents that may not be optimized for today’s rate environment.  

The problem is that so many aspects of trust administration “appear” during the administration process. Because there are so many considerations when drafting a trust, it’s impossible to address them at the time. You cannot predict the future and all the implications of some of the seemingly small aspects of the planning. That is why building a flexible trust structure allows the trustee to make decisions that make sense at the time an issue arises.  

FWR: There is the case of a Health, Education, Maintenance and Support trust, which limits distributions to expenses falling within those categories, providing asset protection, controls to protect inexperienced beneficiaries and preventions from asset inclusion in a beneficiary's federal taxable estate. What's the rate and inflation angle on this?
Stein: HEMS trusts offer flexibility, but they’re not immune to economic shifts. If the trust is invested heavily in fixed income, falling rates can reduce available cash flow. Inflation can also erode the purchasing power of distributions over time. But a HEMS trust may be a better alternative for meeting the current needs of a beneficiary than a traditional mandatory income distribution trust that is more focused on the investments within the trust than the beneficiary’s needs.  

FWR: Another type of trust provides for mandatory distribution at certain benchmarks, for example when a beneficiary reaches specified ages. Again, can you explain the inflation and interest rate implication here and give an example.
Stein: These trusts can be problematic in volatile economic conditions. For example, if a beneficiary turns 30 during a market downturn, the trust may be forced to liquidate assets at depressed values to meet the distribution requirement. Or, in a rising rate environment, there may be downward pressure on the price of bonds that may not recover if the assets are sold and not held to maturity. Inflation also plays a role – what seemed like a generous amount at age 25 may not stretch as far by the time it’s received.

A third type allows the flexibility of discretionary distributions, which might take the form of fixed monthly stipends augmented by distributions for such things as home purchases, education, weddings and large, unexpected expenses.

Discretionary trusts are ideal in uncertain environments. Trustees can tailor distributions – monthly stipends, lump sums for major life events – based on the trust’s performance and the beneficiary’s needs. This flexibility allows for better alignment with inflationary pressures and interest rate shifts, preserving both capital and intent.

FWR: Other methods of trust distributions include fixed amounts adjusted for inflation, or a unitrust, which is a specified percentage of the trust’s value. Can you explain what examples have become more popular and why?
Stein: Unitrusts have gained popularity because they tie distributions to a percentage of the trust’s value, which naturally adjusts with market performance rate, not just interest and dividend rates on the portfolio. Fixed distributions indexed to inflation can work well too, but they require careful investment planning to help ensure that the trust keeps pace with rising costs. These models offer predictability while still adapting to economic realities.

FWR: Trusts can be daunting to people who don't understand how they work and the inflation/rate angle is another layer of complexity, but it need not be. What's your view on how the trusts sector can make it easier to understand?
Stein: Trusts can feel overwhelming, especially when layered with economic factors like inflation and interest rate fluctuations – but that’s exactly where a professional trustee adds tremendous value. A seasoned trustee brings not only administrative expertise but also financial acumen, helping to interpret how changing rates affect distributions, investment strategy, and long-term planning. They can explain complex provisions in plain language, guide beneficiaries through decisions, and help ensure that the trust adapts to evolving conditions without compromising its intent. Professional trustees also serve as neutral parties, reducing family friction and ensuring compliance with fiduciary duties. 

By combining technical knowledge with clear communication, they make trusts more approachable and effective, turning what feels like a maze into a well-marked path.