FEATURE TRUST AND ESTATE LAW
PEGGY K. GARDNER AND MORGAN WIENER, J.
This article discusses the modification of irrevocable trusts, including the recently enacted Colorado Uniform Trust Code.
While its name suggests that an irrevocable trust cannot be changed, it is all too common for a change to such a trust to be desired any number of years after its creation. Historically, trust modifications have been accomplished either through the terms of a trust or pursuant to a court order. Today there is greater flexibility to modify irrevocable trusts through decanting under the Colorado Uniform Trust Decanting Act (UTDA), and when the Colorado Uniform Trust Code becomes effective on January 1, 2019, even more nonjudicial modification options will be available.
This article identifies common reasons to modify irrevocable trusts and various options available to accomplish modifications.
Why Change an Irrevocable Trust?
Common reasons for amending irrevocable trusts after their creation include changes in circumstances, the need for updated tax planning provisions, and administrative provisions that no longer work.
Family Changes and Unforeseen Circumstances
It is impossible for the settlor of an irrevocable or dynasty trust to predict all future events, including the needs of and issues confronting future beneficiaries. Distribution provisions may need to be changed for a beneficiary with substance abuse problems or a spendthrift beneficiary so that trust funds are not dissipated for purposes the settlor did not intend. Similarly, it may be wise to limit distribution provisions for a beneficiary with creditor problems. In a divorce context, mandatory distributions to a beneficiary's spouse could result in additional marital property that is subject to division.1 If the settlor failed to anticipate the needs of omitted successor beneficiaries, the addition of a power of appointment can allow the power holder to provide for new beneficiaries in trust after the original beneficiary's death.
In a blended family situation, there may be tension between income and remainder beneficiaries of a marital trust that puts a family member trustee in a difficult position. In addition, a selected trustee may not work well with beneficiaries who have no power to remove and replace the trustee. Due to tension between current beneficiaries of a pot trust created for multiple beneficiaries, typically the settlor's descendants or children, the trustee may desire to split the pot trust into a separate trust for each beneficiary. In addition, due to changed circumstances, it may make sense to remove a beneficiary as a co-trustee.
It is also difficult for a settlor to anticipate the costs of administration, and at some point in time the costs may outweigh the benefits of continuing the trust. The trust purpose may cease to exist, for example, when a trust was created solely for the educational needs of a beneficiary who is now a 50-year-old practicing physician. And it is all to o common that the terms of a trust for a beneficiary who is either on government benefits or may need government benefits in the future should be changed to prevent the trust assets from being counted as resources of the beneficiary and thus disqualifying the beneficiary for government benefits.
Updated Tax Planning
With respect to a credit shelter trust, if the surviving spouse is not expected to have a taxable estate, it may make more sense to have the trust assets included in the surviving spouse's taxable estate to achieve a step-up in basis at the death of the surviving spouse. A settlor may want to convert a grantor trust to a non-grantor trust or a non-grantor trust to a grantor trust if the trust instrument contains no toggle provision. Significant income tax savings can also often be achieved with a change in trust situs.
It may be wise to extend the duration of a trust exempt from generation-skipping transfer (GST) tax to maximize the tax benefits. In some circumstances, it may be best for a beneficiary if a general power of appointment is converted into a nongeneral power of appointment. In other circumstances, a general power of appointment could be added to a GST exempt trust to obtain a step-up in basis for the trust assets at the death of the beneficiary with the general power of appointment. A trust with a mixed GST inclusion ratio could be severed into GST exempt and non-exempt trusts so that distributions can be made to skip beneficiaries from the GST exempt trust without paying GST tax.
Trustee restrictions, such as a mandatory corporate trustee, may cease to make sense economically, particularly if the trust holds an interest in a closely held business or the trust assets have diminished in value. A recent development in trust administration is the desire to bifurcate trustee responsibilities, such as with a directed trust, where provisions allowing for bifurcation were not included in the original document. A bifurcation may also be helpful if the trust holds an interest in a closely held business or substantial real estate holdings. On the other hand, a trust may not permit a trustee to hold an interest in a closely held business or may direct a trustee to retain such an interest that should be sold due to changes in the financial condition of the business.
It may be desirable to move a trust to a jurisdiction permitting "silent trusts" or appoint a trust protector or director to receive accountings and trust information to avoid notifications to certain beneficiaries if the trustee believes the beneficiaries, contrary to the settlor's wishes, would become overly dependent on the trust.
A trust may contain unclear provisions regarding resignation, removal, and appointment of trustees, or may contain no provision whatsoever regarding appointment of a successor trustee in the event no named trustee is able to serve. Finally, a trust may merely contain outdated administrative provisions, or scrivener's errors may need to be addressed.
Current Nonjudicial Methods for Changing the Irrevocable Trust
Multiple nonjudicial tools are available to enable changes to irrevocable trusts. A few examples of such tools are discussed below.
Authorization Granted in the Trust Instrument
The first step in selecting the appropriate method for modifying an irrevocable trust is to carefully review the trust's terms. The trust may already contain terms that allow desired changes to be made. The trust protector or trustee may have the power to make certain changes to the trust, such as consolidating or dividing trusts, and changing the trust situs and governing law. Beneficiaries may be able to accomplish desired changes to future beneficiaries through the exercise of powers of appointment granted in the trust document.
If the settlor wants to make the trust even more flexible in the future, the drafting attorney should consider
■ stating the settlor's intent as clearly as possible in the trust document;
■ providing expanded distributive discretion to an independent trustee who is not related or subordinate to the beneficiaries under the provisions of Internal Revenue Code (IRC) § 672(c), to more thoroughly use decanting to modify the trust in the future;
■ granting an independent trustee the ability to grant a general power of appointment ( to create estate tax inclusion and the corresponding step-up in basis);
■ adding flexible trust termination provisions for the trustee or trust protector, such as in the best interest of the beneficiaries; and
■ granting the trustee the ability to distribute trust principal to trust beneficiaries to allow the beneficiaries to use the basis increase under IRC § 1014, if distribution otherwise makes sense (for instance, taking into account the possible dissipation of the trust assets by a spendthrift beneficiary and the possibility of a future divorce).
Decanting under the Colorado Uniform Trust Decanting Act
In general, the goal of decanting is to make trusts more flexible to achieve the settlor's material purposes or probable intent if the settlor could have foreseen the changed circumstances that now make modification desirable.2 Decanting is a fiduciary power exercisable only by a fiduciary, typically the trustee.3 A trust director under a directed trust act may also be able to decant if the trust director is acting in a fiduciary capacity.4 Decanting is premised on the trustee's ability to make discretionary principal distributions to or for the benefit of the beneficiaries and cannot be accomplished if the fiduciary has no power to...