Understanding The Difference Between Principal And Income

When researching the topics of trusts and trust administration, Woodland Hills residents may likely hear the terms “principal” and “income” thrown around quite a bit. Understanding what each of these words mean in relation to a trust as well as the differences between them may be vital to the success of a trust as being a source of revenue for its beneficiaries. Knowing such information may also greatly help a trustee as he or she works to allocate a trust’s assets correctly.

As defined by the American Bar Association, principal is the property placed into a trust to benefit beneficiaries (either by producing income or through other means). This may include:

• Money
• Real property
• Stock options

A trust’s principal can be gained or lost by the grantor adding to it or through any gains or losses made through sale of trust property. Judgments awarded to the trust through a lawsuit are also considered to be additions to principal.

Income is any earnings generated by the principal, such as interest earned from trust accounts, dividends from stock holdings or rental fees generated by trust properties. Asset allocations made from the trust will either come from its income or principal.

According to the California Probate Code, receipts and/or disbursements from a trust’s principle and income are to be determined by the trustee in a clearly defined order. First, he or she is expected to make trust allocations in accordance to the trust instrument or will that created it. If no such provisions are included but such documents do empower him or her to use his or her own discretion, then he or she may do so. If no such language is present in any estate documents, the trustee is expected to allocate a trust’s principal and income according to the Probate Code.