The most compelling estate planning strategies often include combinations of trusts that must be irrevocable to achieve specific objectives. Irrevocable trusts create legal “distance” between the trust’s creator and the full control over the trust. The result is often significant privacy, asset protection, and various tax advantages for income, gift, and/or estate tax purposes.
Individuals may be reluctant to create and transfer significant wealth to a trust that they no longer fully control. Moreover, it can be daunting to create a trust that the creator cannot change as circumstances may require. But just because a trust is irrevocable does not mean that it can’t be changed; it simply means that the individual who first established the trust cannot personally change the trust. There are a few useful strategies that allow irrevocable trusts to adapt over time.
Most states allow an irrevocable trust to be modified if all the parties consent, including the creator of the trust, the trustee, and all the beneficiaries. If a beneficiary is a minor or is incapacitated, state law will determine how a representative is appointed to represent that beneficiary in the modification process. If any party objects, or if the creator of the trust is incapacitated or deceased, then the parties who seek the modification may be required to obtain a court order allowing the modification.
While procedural modification provides some flexibility, it requires significant coordination between the parties and the result can be limited and uncertain. One or more beneficiaries may be unavailable or unwilling to participate. Perhaps the trust creator wants to limit the level of information beneficiaries receive concerning the trust. And if the matter must go to court, the family sacrifices a great deal of privacy in their financial affairs.
Decanting occurs when the trustee of an irrevocable trust exercises discretion in making distributions for the benefit of a beneficiary. Rather than distributing the property from the trust outright, the trustee distributes property into another trust.
The trustee’s decanting power may arise from state law or from within the trust instrument. The law generally allows trustees to create a new trust for the benefit of one or more beneficiaries of an existing irrevocable trust and then move assets from the old trust into the new trust. Much like pouring wine from a bottle into a decanter can refresh the wine and improve its taste, decanting assets from an outdated trust into a more modern trust can create improved outcomes for beneficiaries and better express the trust creator’s objectives.
The IRS has provided little guidance on the tax implications of decanting. Before decanting an irrevocable trust, it’s essential to consider potential income, gift, estate, and generation-skipping transfer tax implications of trust decanting.
Most states now recognize the role of another party – separate from the trustee, the trust creator, or the beneficiaries – who holds specific powers in an irrevocable trust. Those powers often include the ability to modify the trust within constraints determined by the trust’s creator. These powerholders have different titles depending on the jurisdiction governing the trust, but most commonly are called “Protectors,” “Advisors,” or “Directors.” Originally found in offshore trusts, the concept of a trust protector has introduced great flexibility in domestic trust planning.
The law that governs the trust determines the scope of a trust protector’s power and the ways in which the protector interacts with the trustee and the beneficiaries. The jurisdictions we most often use provide significant flexibility in how we shape the role of the trust protector. We believe that the protector should ultimately serve the interests of the original trust creator, and that it’s the protector’s job to see that the trust is administered – and if appropriate, modified – to carry out the original trust creator’s objectives over time.
Creating trusts that are “irrevocable” can be intimidating even for individuals with significant estate planning experience. Fortunately, there are sophisticated techniques to allow irrevocable strategies to adapt as circumstances and opportunities demand.