How To unlock irrevocable trusts for maximum benefit

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How to Unlock an Irrevocable Trust for Maximum Advantage April 12, 2014

by Steven J. Oshins, Esq., AEP (Distinguished) and Neil Schoenblum “The f ear of the w ord ‘irrevocable’ of ten causes people to f ail to act and theref ore f ail to take advantage of opportunities that are available.”

Many of our clients f ail to set up irrevocable trusts either because they don’t understand how much f lexibility can be draf ted into the trust or because their advisor isn’t aw are of the available options. Likew ise, those of our clients w ho have already set up irrevocable trusts, but then changed their minds about some of the choices made, of ten don’t realize that many of the provisions can be f ixed or improved. The f ear of the w ord “irrevocable” of ten causes people to f ail to act and theref ore f ail to take advantage of opportunities that are available.

Why Revoke or Amend an Irrevocable Trust?

One reason to revoke or amend an irrevocable trust is that circumstances have changed. For example, the settlor of the trust might have lost his job, gotten sued or divorced, had a health issue or simply misjudged economic conditions that may not have been contemplated at the time the trust w as established.

It is also very possible that the settlor w ill change his mind about how much to benef it each of his heirs, including the possibility that an heir may have a problem that w asn’t contemplated w hen the trust w as initially designed. What happens if the settlor no longer w ants to give anything to an heir? What happens if the heir is going through a divorce and the trust w as established in a jurisdiction that doesn’t protect the trust’s assets f rom the divorcing spouses of the benef iciaries?

What happens if the settlor and the trustees no longer get along or if a trustee is f ound to be dishonest?

In addition, many trusts are draf ted w ith little thought tow ards protection f or the benef iciaries. For example, it is very common f or a trust to make mandatory distributions of one-third of the assets to the benef iciary upon reaching age 25, one-half of the balance upon reaching age 30 and the balance upon reaching age 35. This type of staggered distribution scheme sounds good in theory, but in reality it f ails to consider the asset protection, divorce protection, bankruptcy protection and estate tax savings that most of our clients w ould w ant if given the option to have their trust draf ted accordingly. Many of our clients, af ter discovering that their trusts could have been better-draf ted, w ant to make changes w hich typically are f orbidden since the trusts are irrevocable.

Furthermore, many trusts are set up in a state that has a state income tax that could have been avoided. Although the trust is irrevocable, are there options available to move the trust to a jurisdiction w here state income taxes can be avoided?

New vs. Preexisting Trusts Designing a new irrevocable trust so that modif ications may be made in the f uture and w here common draf ting errors are avoided f rom the outset is much simpler than modif ying a preexisting trust since it is easier to start f rom scratch than to have to w ork through the various issues that exist w hen trying to modif y a preexisting irrevocable trust. Making adjustments to a preexisting trust are much tougher because the ability to make changes is generally limited by the trust agreement itself and applicable state law .

Modifying a Preexisting Trust The f irst step in modif ying a preexisting irrevocable trust is to look at the trust agreement. This w ill help determine w hat options are available.

Trust Protector/Independent Trustee Power to Amend

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Does the trust agreement give a trust protector or independent trustee the pow er to amend the trust agreement? Some trusts provide f or this, w hile many others do not. And if a party does have the pow er to amend the trust agreement, there are of ten restrictions w ithin the applicable provisions that w ould preclude amending the trust agreement f or certain purposes. This of ten is a result of the trust draf tsman trying to provide f lexibility w ithin the document, but yet not give the trust protector or independent trustee so much pow er that items that the settlor w ould not have w anted to be changed can be changed.

Beneficiary Power of Appointment Does a benef iciary have a pow er of appointment? The advisor should check the document to determine w hether a benef iciary has a pow er of appointment w hich gives that benef iciary the pow er to make changes going f orw ard. That benef iciary cannot have a pow er of appointment that w ould allow the benef iciary to make changes f or himself , his estate, his creditors or the creditors of his estate unless inclusion of the trust assets in the taxable estate of the pow erholder w as intended.

If the benef iciary has a pow er of appointment, then the benef iciary can exercise that pow er to change the trust terms in just about any w ay f or the more remote benef iciaries. For example, many irrevocable trusts set up by one spouse f or the benef it of the other spouse give the benef iciary spouse a pow er of appointment to allow the benef iciary spouse to make changes among the benef iciaries. The spouse can reduce a benef iciary’s share, remove that share altogether, change how the benef iciary receives the share or do just about anything else, except as may be limited by the terms of the pow er of appointment.

The settlor’s children generally also have a similar pow er of appointment. It gives each of them the pow er to change how their descendants receive their assets. Very of ten, the grandchildren are young or even unborn w hen the trust is established. Theref ore, planning f or the ability to adjust their shares is an important f lexibility to build into the trust agreement.

Trust Protector/Independent Trustee Power to Add Beneficiaries Does the trust agreement give the trust protector or independent trustee the pow er to add benef iciaries? If so, then, depending upon the class of benef iciaries that may be added to the trust, there may be a w ay to make adjustments to the ultimate shares by simply adding benef iciaries and then having the distribution trustee make a larger distribution to a benef iciary that w as added to the trust af ter the trust w as established. Sometimes the settlor’s spouse can be added as a discretionary benef iciary. Sometimes the spouse is already a discretionary benef iciary. In an emergency, if the settlor needs access to the trust but isn’t a benef iciary, distributions can be made to the settlor’s spouse w ho can then “share” the distributions w ith the settlor. If the settlor w ants to benef it someone w ho w asn’t an initial benef iciary of the trust, then if the trust allow s f or it, the trust protector or independent trustee can add that benef iciary and then the trustee can make distributions to that new benef iciary or modif y the ultimate distributions so that the new benef iciary gets a share.

Choice of State Law – Decanting “There may be opportunities to change the terms of the irrevocable trust by taking advantage of f lexible law s that many states now have.”

Depending upon the choice of state law provision in the document, there may be opportunities to change the terms of the irrevocable trust by taking advantage of f lexible law s that many states now have. The current trend is to modif y an irrevocable trust through decanting. Decanting a trust involves setting up a new trust w ith diff erent terms f or those benef iciaries and then having the trustees distribute the trust assets f rom the original trust into the recipient trust.

A minority of states allow decanting. If the state w here the irrevocable trust is domiciled does not allow decanting or has limited decanting statutes, then the advisor should look at the choice of law provision in the trust agreement and determine w hether the trust allow s the trustee to move the

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trust to a diff erent jurisdiction. If so, then it’s simple to f ind a more f avorable jurisdiction, name a trustee or co-trustee in the new jurisdiction, and then move the trust. Af ter moving the trust, the trustee can decant the trust and make modif ications that may be desired.

Decanting a trust can solve most problems. This area of the law is still undeveloped and many advisors have not yet utilized it. How ever, there are signif icant opportunities f or an advisor to become f amiliar w ith decanting in order to be able to explore more f lexibility f or their clients w ho could use decanting, but might not have been introduced to it.

If the original trust does not allow the trustee to move the trust to another jurisdiction, then the trustee w ill need to check local law to see w hat the def ault law is if the trust is silent. One option if local def ault law s do not help is to have a local attorney petition the court to obtain approval to move the trust to a diff erent jurisdiction. Af ter obtaining court approval, the trust can be moved to the new jurisdiction w here it can then be decanted.

Creating New Irrevocable Trusts – Flexibility New ly-designed irrevocable trusts should be designed w ith as much f lexibility f or change as possible. The trust scrivener should be aw are of the possibility that changes w ill be desired in the f uture and should draf t accordingly. Follow ing are some tips that should be considered in designing new irrevocable trusts.

1. Use a “f loating spouse” as a benef iciary. The “f loating spouse” is def ined as the person the settlor is married to f rom time to time. This means that if the settlor and settlor’s spouse get divorced, then if the settlor gets remarried, the new spouse is a discretionary benef iciary in place of the f ormer spouse. This can be extremely valuable if the settlor ever needs to access any of the trust assets since it is easy f or the trustees to make a distribution to the settlor’s spouse w ho can then share it w ith the settlor. This provision is recommended even if the settlor isn’t currently married since it opens up an interesting potential option in the f uture.

2. Give a trust protector or independent trustee the pow er to amend the document f or certain purposes. There are of ten potential modif ications that couldn’t have been anticipated w hen the trust w as established. Many settlors w ill be glad to have added this f lexibility to their trust agreements.

3. Give the primary benef iciary a pow er of appointment. This is a pow er to amend the document f or purposes of f uture benef iciaries. If the particular f act pattern is such that this w ould be too much control f or the primary benef iciary, then consider giving the pow er of appointment w ith the caveat that it may only be exercised w ith the w ritten permission of the settlor’s close f riend. The f riend can make sure the pow er is exercised in a manner w ith w hich the settlor w ould agree and serve as the w atchdog.

4. The settlor should retain the pow er to remove and replace trustees. Many trusts f ail to provide this pow er even though the tax code and IRS Rulings certainly allow f or it. Be caref ul to design it so that it conf orms to the tax law s. An advanced estate planner w ill be able to draf t accordingly. There are many existing irrevocable trusts w here the trust scrivener did not realize that the settlor could retain this much pow er and theref ore the trust w as draf ted in such a w ay that the settlor lost the indirect control over the transf erred assets.

5. Caref ully select the jurisdiction in w hich to domicile the irrevocable trust.

1. There are many jurisdictions w here trusts are not subject to state income taxes in certain circumstances. This should be considered w hen determining w here to domicile the trust.

2. There are many jurisdictions w here the settlor can be a discretionary benef iciary of the trust, thereby creating w hat is commonly know n as a Domestic Asset Protection Trust. Even better, since there is of ten a concern about w hich state law applies to a Domestic Asset Protection Trust, consider instead using a Hybrid Domestic Asset Protection Trust. This is a trust in w hich the settlor isn’t a discretionary benef iciary initially, but w here the settlor can be added into the trust as a discretionary benef iciary by the trust protector. This f ixes the issues that of ten exist w ith respect to a regular Domestic Asset Protection Trust. The ability to potentially be added as a discretionary benef iciary at a later date is of ten the diff erence betw een a client moving f orw ard

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w ith the planning versus doing no planning as a result of the “w hat if I need it back?” concern. The leading Domestic Asset Protection Trust jurisdictions seem to be Nevada, South Dakota, Ohio, Tennessee and Alaska as ranked by the most recent Domestic Asset Protection Trust State Rankings Chart at http://w w w .oshins.com/images /DAPT_Rankings.pdf .

3. Also consider domiciling the irrevocable trust in one of the leading Dynasty Trust jurisdictions. A Dynasty Trust is an irrevocable trust that continues f or as long as applicable state law allow s. This provides f or estate tax savings and creditor protection f or multiple generations. The leading Dynasty Trust jurisdictions seem to be South Dakota, Alaska, Nevada, Tennessee and Ohio as ranked by the most recent Dynasty Trust State Rankings Chart at http://w w w .oshins.com/images /Dynasty_Trust_Rankings.pdf .

Steven J. Oshins, Esq., AEP (Distinguished) is an attorney at the Law Off ices of Oshins & Associates, LLC in Las Vegas, Nevada, w ith clients throughout the United States. He is listed in The Best Law yers in America®. He w as inducted into the NAEPC Estate Planning Hall of Fame® in 2011 and w as named one of the 24 Elite Estate Planning Attorneys in America by the Trust Advisor. He has authored many of the most valuable estate planning and asset protection law s that have been enacted in Nevada. He can be reached at 702-341-6000, ext. 2, at soshins@oshins.com or at his f irm’s w ebsite, w w w .oshins.com.

Neil Schoenblum, JD, LLM, is a Senior Trust Off icer at Provident Trust Group in Las Vegas, Nevada.

At Provident, he is principally responsible f or overseeing f iduciary administration, w ith a f ocus on personal trust relationships and client service. Neil is a graduate of Northw estern University, Cornell Law School, and the LL.M. in Estate Planning Program at the University of Miami. He can be reached at 702-788-9918, at neil@trustprovident.com, or at Provident’s w ebsite, w w w .trustprovident.com.

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