As most advisors know, clients often call to discuss the unexpected. I'm sure I'm not the only advisor to have had clients call and say, "You remember that irrevocable trust we set up? Well, now I need to change it."
Fortunately, many states have been updating their trust laws in recent years, providing new and simplified techniques to help trustees deal with the challenges of administering irrevocable trusts.
In some of these states, two primary methods -- non-judicial settlement agreements and decanting -- can now help advisors solve many of the problems that arise with irrevocable trusts over time. Not every state currently allows these options, but an increasing number do.
Here's what you should know about each method:
NON-JUDICIAL SETTLEMENT AGREEMENTS
In the past, the main way of solving issues that arose with irrevocable trusts was expensive and often involved going to court. But section 111 of the Uniform Trust Code now allows for non-judicial settlement agreements with respect to trusts.
These agreements enable the modification or termination of an irrevocable trust without court approval -- provided that all interested persons are in agreement and no material purposes of the trust are compromised. Currently, 25 states have adopted some form of the code.
The code makes one other important change. Due to the very nature of a trust, there may be beneficiaries who are either not competent or not yet alive. In the past, a court would need to appoint an individual known as a guardian ad litem to represent the interests of those incompetent and potential beneficiaries. That process added even more complexity and expense.
The code's new provision for virtual representation, however, allows other trust beneficiaries with substantially similar interests to represent the interests of those beneficiaries who are unable to represent themselves -- as long as no conflict of interest exists. For example, it may now be possible for an adult grandchild to represent other minor grandchildren, all of whom are remainder beneficiaries in a trust.
Here is a sample of issues that can be solved using non-judicial settlement agreements and virtual representation:
- Adding specific trustee powers to let the trustee engage in an originally unanticipated transaction.
- Selling real estate from a trust that prohibited the sale because of a misunderstanding in crafting the original trust.
- Updating trustee succession language.
- Altering the way in which the beneficiary is given access to trust assets to take into account a disease, addiction or mental illness developed by the beneficiary.
- Terminating a trust that has outlived its usefulness.
The term decanting is derived from a concept associated with wine: pouring from one container to another in order to leave any non-desired sediment behind.
When used in the context of trusts, decanting is a way for a trustee to transfer assets from an old irrevocable trust into a new one -- presumably with terms that address whatever issue has rendered the old trust no longer desirable. Some states authorize decanting by statute and some authorize it by court decision; it's important to understand which laws will apply.
As with non-judicial settlement agreements, decanting allows a trustee either to fix issues that arise due to outdated administrative provisions in existing irrevocable trusts or to deal with unforeseen circumstances that can occur with particular beneficiaries. For example, the original trust might have restrictive administrative provisions or prohibit a beneficiary from serving as a trustee. A new trust can be created that addresses both of these issues, and the assets can then be moved from the old trust to the new one.
Typically, while beneficiaries will need to be notified, they do not need to consent to the transfer of the assets.
Both non-judicial settlement agreements and decanting introduce new flexibility into the administration of irrevocable trusts. Yet each method should be used carefully.
Also note that the IRS has not issued any guidance on the tax ramifications of either technique. Therefore, it would be wise to carefully consider whether any adverse tax effects could be caused when fixing other existing issues.
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Estate planning attorney Tracy Craig is partner at Mirick O'Connell and chairwoman of the firm's trusts and estates group. Follow her on Twitter at @TracyACraig.