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Estate Planning Blog

Friday, October 27, 2017

Six Ways to Modify an Irrevocable Trust (By Kyle A. Krasa, Esq.)


Your basic living trust is typically “revocable” during your lifetime, meaning that you can change it at any time.  However, once you have become mentally incapacitated or have passed away, your trust becomes “irrevocable.”  Furthermore, advanced estate planning might require that you create a trust that is irrevocable even while you are still living for tax purposes, Medi-Cal planning purposes, or asset protection purposes.  

Even when a trust is technically “irrevocable,” there might be an opportunity to make changes to the trust.  Below are six common methods for modifying an otherwise “irrevocable” trust.

1.  Modification by Consent

Several states allow for the modification of an otherwise irrevocable trust if the Trustmaker and the Beneficiaries all agree.  In California, Probate Code Section 15404 specifically allows this method.  However, this method is not available if the Trustmaker has lost mental capacity or has passed away.  Therefore, utilization of this method is only applicable in limited circumstances.

2.  Judicial / Court Reformation

If the Trustmaker is not able to consent to a modification of an otherwise irrevocable trust, modification might still be possible upon petition to the Court.  Under California law, Probate Code Section 15403 allows for the modification of an otherwise irrevocable trust upon petition to the Court if all of the beneficiaries agree.  If the Court determines that continuation of the trust is necessary in order to carry out a material purpose of the trust, the Court must determine that the reasons for modification of the trust outweigh the material purpose of the trust.  

California Probate Code Section 15409 also allows for the modification or termination of an otherwise irrevocable trust upon petition to the Court without the consent of all the beneficiaries if there are changed circumstances that impair the purpose of the trust.  

The disadvantage to relying upon judicial / court reformation is the time, effort, and expense that are involved in a Court petition.  Furthermore, ultimate authority rests in the discretion of the particular judge who hears the case and thus results may vary.  

3.  Non-Judicial Settlement Agreements

States that have adopted provisions under the “Uniform Trust Code” might provide for the modification of an otherwise irrevocable trust through a “non-judicial settlement agreement.”  The idea is to allow the beneficiaries to agree upon a modification of an otherwise irrevocable trust without having to go to Court.  Approximately 30 states have such provisions and the rules governing who must be a party to such an agreement and what kind of modification is allowed through this method vary by state.  In general, a “material purpose” of the trust cannot be modified by such an agreement.  

Unfortunately, California is not a Uniform Trust Code state and therefore non-judicial settlement agreements are not available for trusts governed under California law.  However, if the California trust contains a “flight clause” – the ability for the trustee to change the governing law of the trust to a different state – then it might still be possible to utilize a non-judicial settlement agreement for the California trust if the governing law is first changed to a more favorable jurisdiction.   

4.  Power of Appointment

Irrevocable trusts sometimes give the beneficiary a “power of appointment”: the ability of the beneficiary to add additional current beneficiaries or to change who receives the balance of the trust after the current beneficiary’s death.  Often powers of appointment are overlooked or not understood by the beneficiaries who do not even realize that they have this power to change the beneficiaries of the trust.  When looking to make a change to an otherwise irrevocable trust, it is good practice to examine whether the trust gives the beneficiary a power of appointment.  

5.  Trust Protector Amendment

Detailed and comprehensive trusts will anticipate that a change to the trust might be necessary in the future if tax laws change, trustee powers need to be modified, or there is a change in the beneficiaries’ circumstances.  To address such issues, the trust might contain Trust Protector provisions which allow an independent party the ability to make certain changes to the trust even after it has become irrevocable.  The particular powers of a Trust Protector can vary dramatically.  Sometimes Trust Protectors are only allowed to make changes under limited circumstances whereas at other times Trust Protectors are given broad authority to modify or terminate a trust.  

The inclusion of carefully drafted and personally tailored Trust Protector provisions can save the beneficiaries considerable expense and uncertainty by specifically providing a method for updating an otherwise irrevocable trust without having to go to Court.  

6. Trust Decanting

Wine aficionados are familiar with the process of “wine decanting”: pouring wine from the bottle into a decanter to separate the sediment.  “Trust decanting” involves “pouring” assets from one trust into a new and updated trust.  Trust decanting is based upon a trustee’s power to distribute trust principal to a beneficiary.  

Some trusts might specifically allow a trustee to decant trust principal to an updated trust.  Similar to Trust Protector provisions, the drafting attorney might think to include such provisions to anticipate a scenario in the future where the trust needs to be updated in an efficient manner that avoids Court involvement.

If the trust does not specifically provide decanting provisions, then it is possible that state law might allow trust decanting under certain situations.  Just as with non-judicial settlement agreements, California does not have decanting statutes.  Therefore, if a California trust does not specifically allow trust decanting, such an option is not available to California trusts unless the trust includes a “flight clause” that allows the trustee to move the trust to a jurisdiction that allows for trust decanting.

Conclusion:

“Irrevocable” trusts are not necessarily set in stone.  If an irrevocable trust needs to be updated, there are a variety of options available to modify an otherwise irrevocable trust.  Good trust drafting will include provisions for the modification of an irrevocable trust without Court involvement under certain circumstances.  However, before modifying an irrevocable trust, care and consideration must be given to whether such a change might impact taxation, creditor protection, or other features of the irrevocable trust.

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Disclaimer: This article is for general information only.  Reading this article does not establish an attorney/client relationship.  Before acting upon any of the information presented in this article, you should consult a competent attorney who is licensed to practice law in your community.








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