April 2014

Changing Trust Terms

Do you know of a trust that you or your client wishes were written differently? For example, if a grandfather established a trust that is operating in a manner that is not meeting the beneficiaries' needs, they might like it changed. When can you change the terms of a trust?

Below are some thoughts on each Level of Planning.

By way of background, a trust is basically a fund of money or other assets established to care for loved ones, charities or other "beneficiaries." It is created in a document that contains instructions for the person overseeing the fund (the "Trustee") to follow in using the assets for the beneficiaries.

Some trusts are revocable and some are irrevocable. If a trust is revocable, you can not only revoke it, but you can also decide to amend or revise it. This makes it easy to adapt a revocable trust to changing circumstances.

On the other hand, while not necessarily obvious, irrevocable trusts can be neither revoked nor, generally speaking, amended or revised. Absent an exception, this means that the trust, as written, will continue to operate according to the exact same terms throughout its life. In North Carolina, this is still the rule, but the exceptions have been clarified since 2008.

You or your client will generally run into an irrevocable trust in 1 of 3 situations:

  • Revocable Trusts that have become irrevocable because of the death of the settlor (the "settlor" is the person who established the trust originally.) Example: grandfather had a revocable trust, but then he died and it became irrevocable.
  • Insurance trusts that were set-up to hold and protect life insurance proceeds.
  • Children's Trusts (sometimes called "Crummey Trusts" after a relevant court case) that were established to receive gifts for children or grandchildren.

So when can you amend these "irrevocable" trusts? In order to override the general rule that says these trusts are not amendable, NC law basically requires at least 1 of 3 circumstances: (1) the consent of the key parties, (2) court approval, or (3) a Trustee with broad power. More specifically:

Consent

You can amend the trust if the settlor and all of the beneficiaries consent. There are detailed rules to deal with "consent" where a minor or incapacitated person is a beneficiary. (Note: in all the cases described in this article, even if state law allows you to amend an irrevocable trust and change its legal terms, you need to separately consider the tax and other consequences.)

Court Approval

Revisions are also allowed if a good reason exists for the change and the court approves. Sometimes not all of the beneficiaries and the settlor are available to sign (for example, because of a death or disagreement.) In this case, the court can approve the revision if you are able to demonstrate a good reason for the change such as:

1. The revision will further the purposes of the trust because of circumstances not anticipated by the settlor;

2. A continuation of the trust on its existing terms would be impractical or wasteful;

3. The settlor's intent and the terms of the trust were affected by a mistake of fact or law; or

4. The amendment will achieve the settlor's tax objectives.

Decanting by the Trustee

Sometimes you don't need consent or court approval for a change. There is a separate procedure where a Trustee (the person who is overseeing the trust funds) can change the way that the trust is operating to some extent. Often the Trustee has discretionary power to distribute trust principal or income to or for the benefit of one or more current beneficiaries. North Carolina law provides that such a Trustee may, without authorization by the court, exercise this discretionary power to distribute principal or income to a Trustee of a second (new) trust. Analogizing to wine being poured from the bottle to another container, this is known as "decanting." The main limitations on decanting are that the beneficiaries of the new trust may include only beneficiaries of the original trust and it cannot reduce any fixed income or annuity to which the beneficiary is entitled.

In conclusion, even if a trust has been in existence for a long time, where it is not fully serving its purpose, there are options. The main bases for changes are: (1) the consent of all of the key parties, (2) the court approves the change based on a good reason and (3) a Trustee has broad authority.