An irrevocable trust is usually created to take assets out of the estate of the grantor mostly to:
- Save on federal or state taxes;
- Remove the assets from potential creditors; or
- Help protect assets when applying for governmental assistance such as Medicaid.
When a trust is first created, the terms may seem sound and reasonable. However, over the years, there may be reasons why the trust no longer works or the circumstances have changed. In order to change the terms of the trust, the trustee usually has to go to court. However, there may be one option to modify a trust that doesn’t require court approval — it’s called decanting.
Trust decanting, which is allowed in some states, is a method for modifying an irrevocable trust. What is beneficial is that you would not have to obtain court approval to modify the trust, which is what usually would have to happen to modify an irrevocable trust. With decanting, the trustee can distribute part or all of the trust principal to another irrevocable trust (called the “appointed trust”). In other words, you pour the assets from one trust to another trust that has different terms.
A list of some of the reasons why decanting might be desired, depending on the trust language and state law:
- To extend the trust’s term;
- To fix drafting errors or makes ambiguous terms clear;
- To move a trust to a state with more favorable laws;
- To adjust powers of appointment;
- To change trustee provisions;
- To combine multiple trusts;
- To separate trusts;
- To convert a support trust to a discretionary trust;
- To convert a trust to a special needs trust;
- To qualify a trust to own stock in an S corporation.
One caveat and something that should be considered when creating an original trust is that it must give the trustee the power to distribute the trust principal. If there is no power to invade the trust principal, the trustee cannot decant the trust.
What state is the best state for decanting a trust? It depends on various regulations and your specific needs. One state or another may be a better jurisdiction to create your trust or attempt to use decanting methods.
In states without a decanting statute, common law may provide the power to decant if the trustee has the authority to invade the trust for the benefit of the beneficiaries. However, a trustee may find him or herself in court if an interested party believes the trustee did not have the authority to decant the trust.
In addition, there is a need to consider tax consequences that may stem from:
- Changing a beneficiary’s rights to, or interest in, the trust principal or income;
- Adding new beneficiaries;
- Adding, deleting, or changing beneficial interests;
- Transferring from a grantor to a non-grantor trust;
- Changing the identity of the donor or transferor for gift or generation-skipping transfer tax purposes.
If decanting a trust seems right for you, discuss the option with your attorney. This is generally a complex strategy but may allow a trustee additional flexibility.