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What are principal and income in a trust?

There are two types of assets associated with a trust in Virginia: principal and income. It is important to know the difference when you create a trust because you will have the option to have your principal distributed one way and your income distributed in a different way to maximize the benefits that the trust pays out.

According to the American Bar Association, the term “principal” refers collectively to whatever assets you place within the trust. “Income” refers to any monetary returns from the property. Appreciation of the assets could constitute income, as could dividends, interests and rents. 

Distinguishing between principal and income allows you the option of distributing assets to more beneficiaries if you so wish, or to the same beneficiaries at different times. For example, you could stipulate that your spouse is to receive the income from the trust but the trustee should divide the principal evenly among your children upon your spouse’s death. As another example, you could arrange that your spouse only gains access to the principal under needful circumstances but receives all the income without restriction. 

It is also important to understand the difference between the principal and income of a trust for tax purposes. If the trust generates taxable income, it will be necessary for your trustee to file an annual income tax form on the behalf of the trust. Additionally, any beneficiaries who are taxable on the trust’s income will have to receive a Schedule K-1 form from the trustee on a yearly basis.

The information in this article is not intended as legal advice but provided for educational purposes only.