Hi, thank you for tuning into today’s Emerald GEM, which stands for Get Educated in Minutes. I’m Jeff Wolken, national director of Delaware Trust Planning for Wilmington Trust Emerald Family Office and Advisory® and your host for today’s podcast. In today’s GEM I’m going to answer the question: How can I modify an irrevocable trust?
One of the most common concerns of families contemplating the use of personal trusts to implement an effective estate plan is whether changes can be made to the trust structures after execution and funding of the trusts. In general, whether a particular trust can be modified depends on whether the trust in question is a revocable trust (one that can be revoked or modified by the settlor in whole or in part) or an irrevocable trust (one that the settlor generally cannot amend or revoke). The irrevocability of a trust is necessary to obtain certain tax advantages in the estate plan, such as completing a lifetime gift to capture the current historically high gift tax exemptions, or to potentially protect the gifted assets from the claims of creditors. However, many families question whether the tradeoff is worth it—irrevocably locking up assets in trust in order to receive the tax and asset protection benefits of a trust.
With these concerns in mind, it may be comforting to hear that “irrevocable” does not necessarily mean “unchangeable.” There may be reasons a family would consider modifying their irrevocable trust, and there are a number of tools available under the law to make these modifications.
Some of the common reasons people seek to modify an irrevocable trust include: changes in the law that impact the trust’s administration, changes in a beneficiary’s ability to manage family resources, changes in trustees, and efficiencies in administration which were not incorporated in the original trust agreement.
One of the most common reasons is the desire to utilize a “directed trust” structure not contemplated by the terms of the original trust agreement in order to divide up the role of the trustee and incorporate family advisors who may direct the trustee regarding trust investments, trust distributions, or other aspects of trust administration.
A change in the financial circumstances of a trust beneficiary is another reason individuals consider modifying an irrevocable trust. For example, an irrevocable trust could potentially be modified to enhance a beneficiary’s current access to the trust’s assets due to challenging financial conditions, or to defer distributions to retain assets in trust to help mitigate federal and state taxes.
When the need to make a change arises, there are many different tools available to implement the desired changes. These tools include the provisions of the trust agreement itself, state laws allowing for a trust decanting or merger, the use of non-judicial settlement agreements, or a more formal court modification process.
Many modern trust agreements build modification tools into the terms of the trust. The trustee or a designated advisor such as a Trust Protector may hold the power to modify the administrative terms of a trust to make it more efficient to administer or to potentially achieve a better tax result. A Trust Protector may also be given the power to remove/replace trustees, change administrative terms of the trust, change the class of named beneficiaries, or change how information is provided to beneficiaries. If this Trust Protector is an “independent” person, they can often hold very broad powers to modify a trust to help a family update their trust in the face of changed circumstances. Changes made pursuant to powers granted to a Trust Protector under the terms of a particular trust are generally documented by a Trust Protector Amendment, which is a private document not recorded in public records or with a court, so this helps keep matters pertaining to the trust private.
Additional modification tools are offered by state laws in trust-friendly states like Delaware, including a trust decanting process, trust mergers, and non-judicial settlement agreements.
A so-called trust decanting is the ability for the trustee to transfer the assets held in an irrevocable trust into a new trust that contains the desired terms. By transferring the assets from the older, outdated irrevocable trust structure into a new, preferable irrevocable trust, the trust decanting can help the family implement the desired modifications.
A trust merger works in a similar fashion to a trust decanting. Instead of the appointment of trust assets from an old irrevocable trust into a new irrevocable trust, a trust merger combines an existing irrevocable trust, which may contain unfavorable or outdated terms, into another irrevocable trust with favorable terms, and the terms of the favorable trust survive the trust merger. There are technical reasons why one tool may be better in each situation, but the results of either a trust decanting or trust merger are similar. By moving assets from the original irrevocable trust into another irrevocable trust with favorable terms, the desired modification can be achieved.
Another tool available in many states is to modify a trust through an agreement among the parties impacted by the modification. Since a court is not required to validate the modification, this tool is broadly referred to as a non-judicial settlement agreement or NJSA. State laws differ regarding the scope of permissible trust modifications available using an NJSA. Delaware is one of a few states that have broad trust modification laws and even permit a complete re-write of the trust agreement if the person who created the trust is alive and provides their consent or non-objection.
In addition, many states sanction agreements that permit modification of certain administrative terms which could otherwise be modified by a court. In general, these NJSAs are an efficient way to update administrative powers or clarify the meaning of trust terms without involving a court.
A final tool to modify a trust is a petition to a court with jurisdiction over the trust to approve a proposed modification of the trust terms. If all parties to a trust consent, most courts will order the requested changes to a trust agreement if the changes are permitted by the applicable state statute. Common changes approved by Courts include changes in trustees or the process to change trustees, changes to administrative powers such as expanding permissible investments, construing the terms of a trust, or dividing a pooled trust into shares along family lines. Due to the uncertain timing and the added expense of a court petition, a formal court modification is often the last tool considered when a family seeks to modify a trust.
In the end, we believe the term “irrevocable” should not be an impediment to using a trust to achieve estate planning goals. An irrevocable trust can provide significant benefits including helping to shield assets held in the trust from estate and gift taxes as well as potentially protecting the trust’s assets from creditors. Since “irrevocable” no longer necessarily means set in stone, there are several tools available to modify trusts.
Thanks again for joining us today. Please contact your Wilmington Trust advisor if you have any questions about how to modify an irrevocable trust. We would be glad to help you.
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