Many estate plans incorporate an irrevocable trust as a key component. But if the trust no longer serves your purposes, you may be wondering if it’s too late to change it. The good news is that, depending on applicable state law, there may be several possible ways to fix a “broken” trust.
How and why trusts “break”
Trusts can fail to serve their intended purposes for a number of reasons, including:
Changing circumstances in the family
If your family circumstances change, a trust that was working fine when you established it may no longer serve its original goals. Divorce, a second marriage, or the birth of a child can all cause a trust to stop functioning as intended.
Changing tax laws
For 2021, gift, estate, and generation-skipping transfer (GST) tax exemption amounts have risen to $11.7 million, which means that trusts designed to minimize these taxes when exemption amounts were relatively low may no longer be necessary. And with transfer taxes no longer as significant, the higher income taxes often associated with irrevocable trusts become more important by comparison.
Accidents
Mistakes such as naming the wrong beneficiary, failing to allocate your GST tax exemption properly, omitting a necessary clause from the trust document, or including a clause that isn’t fully consistent with your intent can also cause a trust not to work properly.
These are just a few examples—there are also many other ways that a trust might fail to achieve your goals for estate planning.
Fixing broken trusts
Depending on applicable law in the state where you live (or in the state where the trust is located), several methods for repairing a broken trust may be available to you. Potential fixes include:
Modifying the trust
If unanticipated circumstances arise that require a trust to change in order to achieve its purposes, this remedy may be available through court proceedings. In some states, modification is permitted with the consent of the grantor and the beneficiaries even if it’s inconsistent with the trust’s original purposes.
Reforming the trust
More than half the states have adopted the Uniform Trust Code (UTC), which provides several options for fixing broken trusts. Similar remedies may also be provided by non-UTC states. During the process of reformation, you may ask a court to rewrite a trust’s terms to better align with the grantor’s intent. Trust reformation is available as an option if the original terms of the trust were based on a factual or legal mistake.
Decanting trust funds
Many states also have decanting laws. Under decanting laws, a trustee may “pour” funds from one trust into another according to his or her distribution powers, even if the new trust has different terms or is in a different location. Although it depends on applicable state law and your specific circumstances, decanting may allow trustees to correct errors, add or eliminate beneficiaries, or take advantage of new tax laws or asset protection laws in another state. In many cases, decanting does not require court approval.
Contact us for assistance
There are many complex rules regarding the modification of irrevocable trusts, and rules can vary dramatically between states. Revising or moving a trust also comes with certain risks, such as uncertainty about how the IRS may view the changes. If you’re considering trying to fix a broken trust, contact us and let us help you understand the potential risks and benefits.