Fixing Irrevocable Trusts That No Longer Benefit Their Beneficiaries

Reuters Legal News

Fixing irrevocable trusts that no longer benefit their beneficiaries

By Eric N. Mann, Esq., and Kathryn Kaler, Esq., Neal, Gerber & Eisenberg LLP JANUARY 31, 2022 The evolution of property and trust law currently allows irrevocable trusts to run in perpetuity for multiple generations, which can enhance creditor protection and minimize transfer tax exposure.

Modern perpetual trusts are supported by a wide range of flexible features to address “blind spots” in planning that cannot be predicted when an individual initially creates and funds these trusts.

Blind spots in planning include unforeseen changes in the law, ambiguities in the trustee’s authority, or the most common, those beneficiaries who could be best characterized as irresponsible and misguided.

Unfortunately, many trusts drafted during the past 50 years could only effectuate a change of the trust terms by seeking court approval, which is costly and time-consuming. In some cases, the trustees and beneficiaries can modify certain provisions by relying on non-judicial settlement agreements, which are helpful in solving administration issues, but did little to remedy troubled beneficiaries.

Today, over half of the states have enacted decanting statutes that provide trustees with the authority to amend or modify the terms of an irrevocable trust without obtaining court approval and in many cases, without beneficiary consent. Decanting is a process that permits a trustee that has the discretion to distribute trust principal to exercise such authority and distribute trust assets to a new trust with modified and modernized provisions for the benefit of any one or more of the current beneficiaries. Decanting is proving to be a new, wonderful tool, to update trust provisions in a manner which best supports the financial and emotional needs of a beneficiary.

Which provisions can be updated?

Generally, a trust may be decanted to: •

modify trust terms to achieve favorable tax status, which may include reducing or eliminating rights of withdrawal or mandatory income interests to avoid estate tax inclusion;

•

correct drafting errors or clarify ambiguous terms;

•

update trust provisions to incorporate changes in the law, such as new trustee powers;

•

convert the trust to a supplemental needs trust to ensure a beneficiary with special needs maintains eligibility for governmental benefits;

•

merge multiple trusts into a single trust or divide a trust with multiple beneficiaries to provide maximum administrative efficiency for beneficiaries;

•

add or eliminate spendthrift provisions;

•

change the governing law for administrative or tax savings purposes, such as minimizing notice requirements;

•

create or modify powers of appointment, which enables beneficiaries to direct trust assets to or for the benefit of a class of persons and determine how those assets are received, whether in trust or outright;

•

and change or update successor trustee provisions.

Decanting is proving to be a new, wonderful tool, to update trust provisions in a manner which best supports the financial and emotional needs of a beneficiary.

While under certain circumstances, a trustee may remove a beneficiary from an existing trust held for multiple beneficiaries (e.g., by moving trust assets to a new trust which excludes the unwanted beneficiary), the trustee may not exercise the decanting authority to add new beneficiaries. In addition, most states prohibit a trustee from exercising the decanting power to reduce or eliminate vested beneficial interests, such as rights to mandatory distributions, current rights to withdraw trust property and presently exercisable general powers of appointment.

Not all decanting statutes are created equal Each state has its own set of requirements for trust decanting, and some are easier to implement than others. For example, some decanting statutes limit a trustee’s decanting authority depending on the scope of the trustee’s distribution authority. These laws distinguish between trusts that provide its trustees with “limited distributive authority,” or the discretion to distribute trust principal which is limited by an ascertainable standard, and trusts that provide

Thomson Reuters is a commercial publisher of content that is general and educational in nature, may not reflect all recent legal developments and may not apply to the specific facts and circumstances of individual transactions and cases. Users should consult with qualified legal counsel before acting on any information published by Thomson Reuters online or in print. Thomson Reuters, its affiliates and their editorial staff are not a law firm, do not represent or advise clients in any matter and are not bound by the professional responsibilities and duties of a legal practitioner. Nothing in this publication should be construed as legal advice or creating an attorneyclient relationship. The views expressed in this publication by any contributor are not necessarily those of the publisher.

Thomson Reuters Attorney Analysis

its trustees with “expanded distributive authority,” or the discretion to distribute principal to a beneficiary for their best interests.

been taken for estate tax purposes, charitable remainder trusts, or grantor retained annuity trusts).

The California, Florida, Illinois and New York decanting laws each provide that trustees with expanded distributive authority may exercise the decanting authority to make both administrative changes and modifications to beneficial interests. Cal. Prob Code §§ 19502, 19511; Fl. Stat. 736.04117; 760 ILCS 3/1202, 1211; McKinney’s EPTL § 10-6.6. However, trustees of trusts sitused in these states who are granted only limited distributive authority may decant a trust, provided that no trust beneficiary may be removed, and each beneficiary’s beneficial interest remains substantially the same following the decant. Cal. Prob Code §§ 19502, 19512; Fl. Stat.

736.04117; 760 ILCS 3/1202, 1212; McKinney’s EPTL § 10-6.6.

While an exercise of decanting authority does not necessarily require beneficiaries’ consent, most states require a trustee to provide notice of the proposed exercise of decanting authority and copies of the existing trust agreement and new trust agreement (or modified trust agreement) to both current and remainder beneficiaries.

Each state has its own set of requirements for trust decanting, and some are easier to implement than others.

In practice, a trustee with limited distributive authority may exercise the decanting authority only to update administrative trust provisions, such as trustee powers or correcting errors and ambiguities, and the trust may not be decanted to reduce or eliminate any non-vested beneficial interests, such as future rights to mandatory income distributions, or create or modify powers of appointment.

Other states, such as Delaware, Nevada, South Dakota and Tennessee, are less restrictive and merely provide that a trustee who has the discretion to distribute trust principal, regardless of whether the trustee has expanded or limited distributive authority, may decant a trust to amend administrative provisions and modify beneficial interests. 12 Del. C. § 3528; N.R.S. 163.556; SDCL 55-2-15; T.C.A. § 35-15-816.

In addition, trustees of trusts sitused in these states may exercise the decanting authority to reduce or eliminate mandatory income distributions (other than trusts for which a marital deduction has

In states like California and Illinois, the trustee needs to provide 60 days advance written notice of the intended trust decant to all of the following: the grantor, each current and presumptive remainder beneficiary, each holder of a presently exercisable power of appointment, each person who has the authority to remove or replace any fiduciary, each fiduciary (including trust advisors), and, for trusts that contain a charitable interest, the Attorney General. Cal. Prob Code § 19507; 760 ILCS 3/1207. Statutory notice requirements can be problematic for trusts with litigious beneficiaries who may object to a proposed decant, or clients who wish to maintain privacy regarding trust assets.

A handful of trust-friendly jurisdictions, such as Delaware, Nevada, South Dakota and Tennessee, do not require a trustee to provide notice of the proposed decant to current or remainder beneficiaries, or any other interested party. 12 Del. C. § 3528; N.R.S. 163.556; SDCL 55-2-15; T.C.A. § 35-15-816. In some cases, it might make sense to move the administration of a trust to a jurisdiction with more favorable trust decanting laws by simply migrating the trust administration to said jurisdiction. This would require a trustee located in said state.

Concluding remarks Historically, modifying irrevocable trusts has been a timeconsuming and costly process, especially where changes were targeted to address a troubled beneficiary. Thankfully, with the evolution of trust decanting laws across the United States, trustees now have a tool at their disposal to update, and in some cases, repair the operation of a trust for the best interests of the beneficiaries.

About the authors Eric N. Mann (L) is a partner in Neal, Gerber & Eisenberg’s Private Wealth Services. He provides gift, income and charitable planning strategies for high-net worth individuals both domestically and internationally, and counsels on all aspects of estate and trust administration including gift and estate tax audits. He can be reached at emann@nge.com. Kathryn Kaler (R) is an associate in the firm’s Private Wealth Services practice group. She focuses her practice on estate planning, charitable planning, and the formation and operation of nonprofit entities. She can be reached at kkaler@nge.com. The firm is located in Chicago.

This article was first published on Reuters Legal News and Westlaw Today on January 31, 2022.

© 2022 Thomson Reuters. This publication was created to provide you with accurate and authoritative information concerning the subject matter covered, however it may not necessarily have been prepared by persons licensed to practice law in a particular jurisdiction. The publisher is not engaged in rendering legal or other professional advice, and this publication is not a substitute for the advice of an attorney. If you require legal or other expert advice, you should seek the services of a competent attorney or other professional. For subscription information, please visit legalsolutions.thomsonreuters.com.

2 | January 31, 2022

©2022 Thomson Reuters