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Income trusts hold income-producing assets for investors, but there are a few different types to be aware of. Here’s what you should know about income trusts and how they work.
Understanding income trusts
Income trusts hold assets that generate income and can be structured as personal trusts or publicly-traded trusts that issue shares, such as real estate investment trusts (REITs).
Personal trusts may be used in estate planning where a trust fund is set up to make distributions to beneficiaries. Publicly-traded trusts are required to distribute the vast majority of their income to shareholders.
Personal vs. publicly-traded income trusts
Personal income trusts are often used in estate planning or managing family assets. A trustor may set up a trust, which is managed by a trustee, as a way to control distributions to the trust’s beneficiaries. There may also be controls around how the trust is invested.
Publicly-traded income trusts manage a portfolio of income-generating assets and distribute that income to shareholders. For example, a REIT may hold various apartment complexes that generate rental income and then distribute those payments to the trust’s shareholders. REITs are required to distribute 90 percent of their taxable income to shareholders.
Types of income trusts
- Investment trusts
- Investment trusts pool money from multiple investors to invest in securities such as stocks and bonds. They are commonly known as mutual funds, and are managed by fund managers who make decisions on the shareholder's behalf.
- Real estate investment trusts own various types of physical properties such as apartments, office buildings or even cellular towers. The assets generate income that is then distributed to shareholders.
- Royalty trusts
- Royalty income trusts allow investors to generate income from energy assets, such as oil or natural gas. Once the energy asset is depleted, the trust is dissolved.
- Business trusts
- A business trust is used to hold a stake or interest in a particular business. Personal trusts often hold a diversified portfolio of assets, but a business trust may hold a stake in a single company. A business trust may have a single or several beneficiaries.
Benefits of income trusts
- Trusts aren’t taxed directly, but individuals are taxed on the income they receive from the trust. It avoids the issue of double taxation, which can occur when corporations pay taxes on earnings and then pay dividends to shareholders that are also taxed.
- Investors looking for income can easily invest in a portfolio of income-generating assets such as REITs.
- Income-generating assets held within a trust may be less risky than other assets.
Considerations and risks of income trusts
- Income generated from trusts isn’t guaranteed. The portfolio is only as strong as the underlying assets it holds, so the money in a trust could dry up if it’s not invested wisely.
- Rising interest rates could hurt the prices of publicly-traded trusts because income-seeking investors can find attractive returns elsewhere.
- Trusts can be complex to understand for novice investors.
Income trusts hold income-generating assets that distribute funds to beneficiaries and shareholders. They can exist in several different forms, but are commonly used in estate planning for wealthy families and may be publicly traded in the form of REITs.
Financial advisors may be able to help in setting up a personal trust or in identifying REITs to invest in. Bankrate’s financial advisor matching tool can help you find a financial advisor in your area.