Irrevocable Trusts are often included as part of a comprehensive estate plan and are usually established many years before they pay out or terminate. These trusts didn’t change with changes in beneficiary circumstances or with evolving legislation, but now they can. This article explores how.
This second part of a three-part series discusses changes to irrevocable trusts using decanting. The first part explored Changing “Irrevocable” Trusts Through Judicial and Nonjudicial Modifications, and the final part will review the use of a Trust Protector to modify an otherwise irrevocable trust.
Unlike judicial and nonjudicial modification or the use of a Trust Protector, decanting relies upon an extension of the trustee’s existing power to distribute trust assets. In states that recognize decanting, the trustee exercises their power to distribute trust assets and moves them from a trust with unfavorable terms to a trust containing more favorable terms, much like pouring wine from the bottle into a decanter brings better flavor to the wine.
Depending upon state law, the new trust could provide opportunities to correct a drafting mistake, clarify ambiguities, correct and update trust provisions, remedy problems in administration, change trust situs, expand or limit trustee powers, restrict beneficiaries’ rights to information, provide asset protection, adjust trustee succession, appoint a trust protector, alter distributions, or adapt trust provisions to address changes in beneficiaries’ circumstances. Over half of all states have enacted statutes authorizing decanting. Each state’s statutes regarding decanting vary widely, although most recognize that if a trustee has discretionary power to distribute trust corpus to the beneficiaries, such power constitutes a special power of appointment enabling the trustee to appoint the trust corpus to a new trust for the benefit of those same beneficiaries.
Even if your state statutes do not specifically authorize decanting, you may still have options. If the problematic trust allows for a change in situs, then the trustee or other authorized party can utilize that provision to move the administration of the trust to a state that allows decanting. Once the trustee changes situs, then the trustee can take advantage of the new state’s decanting statutes. Most states that allow decanting have adopted some form of the Uniform Trust Decanting Act. Note that experts tend to cite South Dakota as the state with the most favorable decanting statute.
Let’s review an example to see the practical application of decanting. Assume that Donald established a trust for the benefit of his nephews, Huey, Dewey, and Louie naming Webby Vanderquack as Trustee (Webby is an independent trustee because she is not related or subordinate to Donald). Webby makes distributions to Huey, Dewey, and Louie in her sole and absolute discretion and the terms of the trust provide for outright distribution to each of Huey, Dewey, and Louie in a few years. Huey recently became disabled and receives government benefits. Huey has expressed concern that he will lose his benefits if he receives the trust assets outright. Dewey just finished his third stint in rehab and Louie is in the middle of a nasty divorce. Webby proposes to decant the trust assets to a new trust that contains a special needs trust for Huey’s benefit and lifetime trusts for each of Dewey and Louie. This new trust provides additional protections for Huey, Dewey, and Louie, based upon circumstances that Donald could not have reasonably anticipated when he established the trust. This is but one example of the myriad ways that decanting allows the Trustee to create a new trust that better addresses the beneficiaries’ needs without unfavorable tax consequences.
If you think that decanting might provide a solution for your trust troubles, make sure that you consult a qualified Estate Planning attorney regarding your state’s decanting rules. The trustee needs to comply with their fiduciary duties which becomes more difficult if the trustee occupies the dual role of trustee and beneficiary. You want to ensure that you avoid unintended tax consequences to the grantor and beneficiaries.
Decanting provides a great estate planning opportunity in the current environment. Trust and Estate attorneys and clients alike are encouraged to review their plans, especially irrevocable trusts created many years ago to confirm that those trusts accomplish the goals of the grantor and properly protect the needs of the beneficiaries. If the trust fails to properly address beneficiary needs or otherwise could use some tweaking, decanting provides a great opportunity to re-write the trust with more favorable terms.
The final article in this series will examine modification of a trust by the use of a Trust Protector.
Tereina Stidd, J.D., LL.M. (Tax)
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128