Irrevocable trusts are important tools in estate planning for many different reasons. For those of modest means, an irrevocable income -only trust is a great way to protect your home and non-retirement assets from the costs associated with long-term care. For the affluent, irrevocable trusts can be a way of saving state and federal estate taxes, as well as state-level income taxes. While setting up a trust that sounds as if its terms are unchangeable can be daunting to some clients, a good lawyer can also quickly explain that an irrevocable trust, despite its name, is subject to change and amendment. Below are four techniques that will allow you to reap the advantages of an irrevocable trust while maintaining the control and flexibility that are the hallmarks of any good estate plan.
1. Exercise of a Power of Appointment
Many irrevocable trusts contain a mechanism known as a power of appointment. This mechanism allows certain individuals to redirect where the trust assets will go. There are two main types of power of appointment: a general power of appointment, in which the holder of the power can appoint property to him or herself, and a limited or special power of appointment, in which power holders cannot appoint trust property to themselves, their creditors, their estates, or the creditors of their estates.
Sometimes, these powers may be exercised by simply filing a notarized instrument with the trustee, and at other times, they may be exercised via the power holder's last will and testament. These mechanisms are often baked into the trust terms to allow planning for future unseen events and provide flexibility in planning. The exercise or non-exercise of these powers can have significant tax and asset protection implications. Consult with your attorney before implementing any changes to an estate plan via this mechanism.
2. Use a Non-Judicial Settlement Agreement
A non-judicial settlement agreement, or NJSA for short, is an agreement among the trust's beneficiaries, the trustee, and potentially the trust's grantor to alter the terms of an irrevocable trust.
Effectively, if all of the parties to a trust agree to alter its terms, then the trust can be amended. Short of obstructing the trust's initial purpose, an NJSA provides trustees and beneficiaries with a virtually unlimited ability to amend the terms of a trust. An NJSA can also be used to terminate a trust when all parties agree that the initial purpose of the trust has been fulfilled and that continuing the trust would be an uneconomic endeavor.
3. Decanting
Much like pouring a bottle of wine from one container into another, the decanting of a trust can be used to accomplish an amendment of the trust's terms without disturbing its underlying purpose. An important distinction from an NJSA is that a trustee can usually carry out a decanting without the consent of current or future beneficiaries.
Decantings are best used when the administrative provisions of the trust need to be updated to address some unexpected change in either the practical administration of the trust or tax law. For example, a trust may provide that is governed by New York law, but if the majority of the beneficiaries have now relocated to other jurisdictions, the trustee may find that the tax laws of, say, Florida or New Hampshire might provide a better tax result.
Another instance where decanting might help is if the original trust instrument fails to provide for an adequate succession of trustees due to an intervening death or dementia diagnosis. Here, the trustee can establish an adequate succession mechanism without petitioning the court.
Importantly, decanting cannot usually be used to change a trust's material purpose or substantially alter a beneficiary's interests. It is thus best used when administrative changes need to be made. These changes may seem minor but can result in long-term savings and efficiency in administration.
4. Judicial Reformation
When all else fails, a court can be asked to intervene upon the petition of a grantor, trustee or beneficiary to alter the terms of an irrevocable trust. As one may imagine, this process can be time-consuming, and judges are likely to closely scrutinize any requested change that does not have the consent of an interested party. This is the most costly mechanism by which to change a trust and perhaps the route that is least likely to succeed. When drafting a petition to change the terms of an irrevocable trust, care should be given to request a very narrowly tailored remedy that will not upset the beneficial interests of the parties involved. In our experience, judges are more likely to approve such things as the appointment of successor trustees, requests for changes in the situs of administration, and similar changes of an administrative nature. A petition seeking the removal of trustees and changing of beneficial interests is generally an uphill battle and should only be undertaken as a last resort.
Other Possible Avenues to Explore
Sometimes, more than the above methods are needed to address the situation. Prudent trustees might terminate a trust and start from scratch by distributing the trust assets to an eligible and cooperative beneficiary. Care must be taken, however, regarding the gift tax implications of such a strategy. Similarly, trustees should be transparent with beneficiaries, consistent with their duty to inform and duties of good faith and fair dealing. The revision of an irrevocable trust's terms often involves practical and ethical considerations that are implicated by the trustee's fiduciary status. This is especially true when the trustee is a current or future beneficiary. Before undertaking any preceding steps, trustees should seek legal counsel to thoroughly address the practical, tax, and fiduciary dimensions involved.