Pasternak & Fidis Reporter

August 30, 2018

Changing Irrevocable Trusts

When is a door not a door? (Answer: When it is ajar.)

When is an irrevocable trust not irrevocable? Answer: Pretty much all the time. That is, perhaps the irrevocable trust cannot be revoked per se but, with a little creative thinking and cooperation, it may be possible to modify, decant, or terminate an irrevocable trust. This is not the kind of news that makes headlines (except in our newsletter), but great changes are afoot in trust planning.

In the past 18 years, more than 30 jurisdictions (including DC, MD, and VA) have enacted a version of the Uniform Trust Code, shifting trust law away from arcane rules buried in old court decisions and into the modern era. Many jurisdictions (again including DC, MD, and VA) have also revised laws that used to prohibit extremely long-term trusts, making it possible to create irrevocable trusts that last indefinitely—perpetual or “dynasty” trusts. None of these changes has given estate planners a reliable crystal ball, however, so one innovation of modern trust law is
flexibility for irrevocable trusts.

Often, estate planners will draft for flexibility. With few exceptions, the terms of a trust supersede any contrary provisions of a state’s trust code, so the best place to make a trust flexible is at the drafting stage, in the trust’s language itself. There you may find provisions that:

• Make it easy to add or change trustees;
• Give the beneficiary the power to direct where the remaining trust assets should go at her death;
• Give the trustee broad discretion to distribute income and principal to and among members of a class of beneficiaries (and/or to withhold distributions to a beneficiary for any number of reasons), perhaps even to the point of terminating the trust;
• Authorize trustees, individual beneficiaries, or third parties to select charities to receive distributions;
• Give trustees or a trust protector the power to amend some of the trust’s terms (often to make administration less burdensome or to save taxes);
• Give trustees the power to move the trust to another jurisdiction to take advantage of more favorable laws;
• Allow the beneficiary to decide whether to withdraw assets from the trust or leave them in place;
• Give the trustee the power to confer upon a beneficiary more expansive control over her own trust; or
• Give the trustee the power to decant the trust (see below).

Such provisions build flexibility into the trust’s terms, making it less likely that court involvement will be necessary ten, twenty, eighty, or more years in the future when law changes, beneficiary circumstances, or anything else may create unexpected problems that cannot be resolved without a court.

If the trust’s terms are inflexible, state law may provide needed flexibility; the state’s trust code may allow for certain changes to be made if all relevant persons are in agreement and the court blesses the proposed changes—and it may even allow for such changes to be made without going to court. Many jurisdictions that have enacted the Uniform Trust Code (including DC, MD, and VA) permit non-judicial settlement agreements to modify or terminate otherwise irrevocable trusts as long as (i) the relevant cast of characters agrees to it and (ii) the changes do not violate a material purpose of the trust. In determining the relevant cast of characters—those persons whose OK is needed for the agreement to take effect—many state laws (including DC, MD, and VA) now allow for virtual representation. This means that it may not be necessary to get Beneficiary Betty herself to sign off on the deal if someone else can sign off and bind Beneficiary Betty to the deal in doing so. Typically, the virtual representation rules allow for a parent or other ancestor to agree on behalf of a minor or unborn beneficiary, allow one beneficiary to agree on behalf of another beneficiary whose interest in the trust is substantially identical, and persons with special powers over the trust to agree on behalf of contingent beneficiaries or others whose interests could be defeated by the exercise of such powers. State laws differ in the logistical details, but in some situations it may be possible for the trust’s settlor to designate someone to have authority to represent and bind a beneficiary with regard to trust matters, including with respect to non-judicial settlement agreements.

If the state law governing administration of the trust is not sufficiently favorable to allow for the desired changes, the state law may nevertheless allow the trustees to shift the trust’s situs to a new jurisdiction, where the laws are more favorable.

Virginia, like a number of other states, permits trust “decanting.” This is the term used to describe a trustee’s act of “pouring” assets of one trust into a new trust—presumably, a trust with more favorable terms. Decanting can be a simple and effective tool for changing administrative or ministerial provisions or achieving better tax-efficiency. Changing beneficial interests—within limits—is also possible via decanting, but state rules vary a great deal as to the prerequisites for decanting and how far from the original trust’s terms the new trust may legitimately stray. The restrictions tend to focus on protecting the trust’s material purposes and beneficiaries’ interests; even if the original trust’s place of administration is a state that permits decanting, it may be necessary to move the trust to a decanting-friendlier jurisdiction before proceeding with changes that push the envelope.

Changes made to irrevocable trusts can affect tax treatment as well as beneficiaries’ interests, trustees’ powers and duties, and even the rights of beneficiaries’ creditors to reach trust assets. It is very important to seek advice from competent trust counsel before undertaking changes that may have unexpected repercussions, but an “irrevocable” trust may not be as irrevocable as it appears. Our estate and trust attorneys would be happy to assist you with any questions you may have about irrevocable trusts.