When an irrevocable trust needs to change

Historically, trusts were limited in duration and difficult to modify without going to court. As trust law has evolved over time, many states have eliminated old laws limiting how long property can remain in trust and created new laws offering ways to modify trust terms, especially administrative terms, through nonjudicial means. Today, there are many ways to modify an irrevocable trust without the time and expense of going to court—and many reasons such modifications might be necessary. “The need for change often depends on why a trust was created in the first place and how it was drafted,” says Michelle Minon, Market Trust Executive for Bank of America. 

If, for example, a trust’s primary purpose is to provide support for future generations of a family, then adjustments to trust structure or language could be required in the wake of a marriage, divorce or the birth of new children to ensure fair and equal treatment of all future beneficiaries. And because most irrevocable trusts are intended to leverage strategies for tax efficiency, a trust may need to be modified when tax rules change. Here are some considerations about why, when and how trust grantors or beneficiaries and their estate attorney might modify a trust.

Some trusts make modification easy

Trust flexibility starts with the trust agreement that governs the trust. The easiest way to ensure that a trust will stand the test of time is to have trust language drafted that will accommodate the need for future modification. Grantors should talk with their attorneys about how to include in a trust agreement limited modification or amendment powers that enable the trust terms to adapt to changing needs.  

One way to do this is to grant powers of appointment in a trust agreement. For example, the agreement might include language giving a surviving spouse the ability to adjust distributions made to the couple’s children after the grantor’s death, Minon says. That ability, known as a limited power of appointment, could allow the surviving spouse the option of keeping assets in trust for a troubled offspring rather than making a direct distribution at a particular age, as the trust might otherwise stipulate. Or the surviving spouse could choose to make early distributions to the couple’s children, rather than waiting until the surviving spouse’s death.

A trust agreement might also appoint a trusted friend, family member or estate planner to act as a “trust protector”: a person who is granted special powers to adjust trust terms to adapt to changed circumstances. A trust protector’s powers can be narrow or broad, depending on a grantor’s preferences. A flexible trust agreement might give a trust protector the power to remove and appoint fiduciaries, amend administrative provisions or even add or remove beneficiaries. “Having a trust protector can be an effective way to amend a trust in ways that go beyond what a corporate trustee would do,” says Sarah Ziegler, Market Trust Executive for Bank of America Private Bank.

Fiduciary modification methods

Sometimes even an inflexible trust agreement can be modified. Many states now allow irrevocable trusts to be modified through special estate planning techniques that can be used to combine or divide trusts. These modification techniques include decanting and merger, and they are usually implemented by the acting trustee (or another fiduciary) of the trust.

Decanting. Decanting is a process whereby the assets of one trust are “distributed” to another trust with one or more of the same beneficiaries and new or updated terms. “Decanting” refers to “pouring” assets from one trust into another trust, just as you might decant wine from a bottle into another vessel. “Some states, like Delaware, allow a trust to be decanted into another trust or into the same trust with modified terms,” says Molly Bailey, Regional Fiduciary Advisor for Bank of America.

The main prerequisite for decanting is that the trustee must have the power to distribute trust principal (and not just trust income). In states that permit it, decanting can be used to update administrative provisions in a trust agreement, grant or adjust fiduciary or beneficiary powers and responsibilities and even make changes to beneficial interests.  

Decanting is often used to address differences in investment risk appetite between corporate trustees and their clients. Corporate trustees have a fiduciary duty to choose trust investments that are diversified to help protect against risk of loss. Sometimes, though, a family may be comfortable with the risks that come with a less diversified portfolio. “Suppose a family is adamant that all of the trust assets remain invested in the stock of a family company,” Bailey says. “That’s a decision that will be difficult for a corporate trustee to justify as prudent. Under such circumstances, a corporate trustee might consider implementing a decanting to achieve the family’s pursuit of formal control over trust investment decision-making.” 

Merging. Merger is a process whereby one trust is combined with another. Functionally equivalent to decanting in many respects, merger is often used when decanting is not an option. “Decanting can’t happen unless a trustee has the power to invade trust principal,” Bailey says, “which means that an income-only trust is not eligible for decanting.” With an income-only trust, or in other circumstances in which a trustee does not have the power to distribute trust principal to the beneficiaries, merger might be an option. “In those situations, a trust merger often can be used to combine one or more trusts with substantially similar terms and may accomplish many of the same goals of decanting,” Bailey says. “Merger is a powerful modification technique that can be used to consolidate trusts with similar beneficial interests, update and adjust fiduciary powers and responsibilities and reduce administrative expenses.”

Other nonjudicial modification methods

In addition to fiduciary modification methods, there are other ways to modify a trust with the participation of the trust grantor, trust beneficiaries or both. When the family directly participates, a nonjudicial settlement agreement (NJSA) or a nonjudicial modification agreement (NJMA) can often be used to implement extensive changes to a trust agreement. “The process is much simpler if the grantor is still living and all of the beneficiaries are alive and have reached adult age,” Ziegler says. If that’s the case, the grantor, the trustee, a trust attorney and the beneficiaries can get together and agree on what needs to be altered, using an NJMA. If the grantor has died, the trust can be modified through an NJSA, which works much as an NJMA does.

There are special risks and limitations to these approaches. “In general, unless the grantor is participating in the modification directly, neither the NJSA nor NJMA approach can be used to alter any of the grantor’s material purposes in establishing a trust,” Bailey says. These nonjudicial modification approaches also bring the risk of unintended tax consequences and should be implemented only under the advice of legal counsel.

Regardless of which method of modifying a trust is being considered, all persons with an interest in that trust need to be kept in the loop about plans to make changes. “That could include beneficiaries who may not even know about the trust,” Ziegler says. “Before we send out notice about the modifications, we try to talk with everyone who may be involved and explain what is happening and why.”

How Bank of America can help

For families who have an irrevocable trust, or who are considering drafting or modifying one, Bank of America can bring together a range of specialists with expertise about trusts and estates. Bailey leads a Bank of America work group on trust modification, designed to help families who are considering trust changes. “We talk through all of the options and see which one might be appropriate,” she says.

“Trusts are really about who our clients are as people, what keeps them up at night,” Ziegler says. “Our job is to understand that and to help them create and protect the legacy they want.”