What Are Income Trusts?

An income trust is a type of investment structure that generates cash flow by holding assets that produce steady income, such as real estate, energy infrastructure or businesses. Investors buy units in the trust, which then distributes most of the income earned from these assets directly to them. Income trusts are popular for those seeking regular distributions, often similar to dividends, making them attractive to retirees or anyone focused on generating passive income. While income trusts can offer substantial cash flow, their value can also be influenced by factors like interest rates and the performance of the underlying assets.

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What Are Income Trusts?

Income trusts generate income for investors by holding profitable assets on their behalf. Individuals can create private income trusts for themselves and their families. Some trusts, such as real estate investment trusts (REITs), sell tradable shares accessible to the public.

Generally, the purpose of a trust is to earn and distribute income consistently. For example, if you want to provide income for your children or beneficiaries, you would create a personal trust fund and hire a trustee to oversee it. The trustee’s job is to manage and acquire profitable assets that produce sufficient income for you or your beneficiaries.

A personal trust’s creator, or trustor, defines how the trustee invests money and distributes income. As a result, personal trusts allow you to set up inheritances and limit beneficiaries’ control of the fund.

On the other hand, publicly traded trusts in the United States follow a strict set of laws to operate. Income trusts must hold diversified assets, issue 90% of their income to investors, and focus on industry-specific investments. For example, REITs can’t invest in energy.

Types of Income Trusts

Investors considering income trusts will encounter four types in the market:

Royalty trusts: Royalty trusts create revenue by investing in energy sources, like natural gas or oil wells. Royalty trusts don’t extract energy but own the rights to energy sources or the land containing them.
Investment trusts: Commonly known as mutual funds in the United States, investment trusts are companies that invest in a diversified collection of stocks, bonds, and other assets.
Real estate investment trusts: REITs invest in commercial real estate and personal mortgages. You can buy shares of REITs publicly like you can with mutual funds. The Hines Global Income Trust is an example of a publicly listed REIT that invests in real estate all over the world, while the Blackstone Real Estate Income Trust is a non-listed REIT that focuses on domestic properties.
Business trusts: While many companies sell investors shares of stock, some companies use an income trust model, usually for tax advantages. Business trusts differ from other income trust types because they come from just one company instead of numerous diversified assets. For example, public utility companies often form business trusts. As a result, your local power company may be investible as an income trust.

Pros and Cons of Investing in Income Trusts

Income trusts come with a mix of benefits and risks that potential investors should consider. While they can offer steady income and portfolio diversification, they also carry challenges like fluctuating distributions and limited liquidity. Below are some of the key pros and cons of investing in income trusts.

Reasons to Invest in Income Trusts

Regular income: Income trusts are known for distributing most of their earnings to investors, providing a steady stream of income, often on a monthly or quarterly basis.
Tax efficiency: Income from these trusts may qualify for favorable tax treatment compared to other investment income, depending on the investor’s location and the structure of the trust.
Diversification: Income trusts often hold a diversified range of assets, such as real estate or infrastructure, providing exposure to different economic sectors that can enhance an investor’s portfolio.
Potential for capital appreciation: Some income trusts have the potential for capital gains, especially when underlying assets increase in value.

Risks of Investing in Income Trusts

Fluctuating distributions: Income distributions can vary, depending on the performance of the trust’s assets, which may affect the predictability of income for investors.
Interest rate sensitivity: Many income trusts are sensitive to interest rate changes, with rising rates potentially leading to a decrease in the value of the trust’s units.
Management fees: Management costs and fees can erode returns, particularly if the trust has high administrative expenses.
Limited liquidity: Some income trusts are not publicly traded, which can make it challenging for investors to sell their units quickly.

Income Trust vs. Qualified Income Trust

Although they sound similar, an income trust and a qualified income trust serve different purposes and appeal to different needs.

A qualified income trust, commonly known as a “Miller Trust,” is utilized to help meet Medicaid eligibility requirements. It is specifically intended for individuals whose income surpasses Medicaid thresholds but who still require financial support for long-term care expenses. By placing income into a qualified income trust, an individual can become eligible for Medicaid assistance, since the income held in the trust is excluded from eligibility calculations.

Meanwhile, an income trust is an investment vehicle that provides cash flow to its unit holders. It’s structured to hold assets like businesses or properties that generate income, distributing most of it to investors. This type of trust is typically used for financial returns and often appeals to those seeking regular income from their investments.

The key difference is in their purpose: income trusts generate passive income for investors, while qualified income trusts help individuals qualify for essential healthcare support through Medicaid.

Bottom Line

Income trusts are apt for creating a monthly revenue stream and reducing taxes. If you create a personal income trust, you can arrange your estate to provide payments to your beneficiaries. On the other hand, you can invest in publicly traded income trusts as you would stocks or bonds. While income trusts usually hold diversified portfolios, it’s a good idea for investors to do their homework before putting money into one.

Portfolio Management Tips

If you’re not sure which assets belong in your investment portfolio, consider speaking with a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you’re looking for alternatives to traditional stocks, income trusts are just one option. Use this guide to explore how to go beyond conventional investments.