They say that even the best laid plans can go awry, and many clients who meticulously planned for the future by establishing irrevocable trusts may now regret the terms of those trusts—or the asset allocations that they chose.  ortunately for these clients, irrevocable no longer really means that the trust terms are set in stone because half of the states now allow a process called “decanting” that can provide a method for clients to change the terms of their irrevocable trusts. 

Clients who wish to take advantage of these laws must be aware of the intricate variations between the laws of each state and carefully evaluate those rules to determine whether their particular trust can benefit from the decanting process.

Trust Decanting Defined

Essentially, decanting a trust means distributing the property from an old trust into a new trust (with new and presumably more favorable trust terms) for one or more of the old trust beneficiaries. Assets that remain in the old trust will continue to be governed by its terms (if the old trust is emptied, it can simply terminate). It is the trustee who executes the trust decanting process, using powers either granted by the old trust itself, state law or common law rules.

There are a variety of reasons why a client may wish to decant an old trust. For example, the old trust may provide distribution terms that are no longer advantageous because of either the growth rate of the trust assets or the personal situation of the beneficiary (who may have divorced, become financially irresponsible, etc.). The client may simply wish to change the governing law of the trust to a more tax-friendly state or combine several similar trusts established for the same beneficiaries.

The trust need not be established in one of the states that allows for trust decanting, because the old trust can simply be “decanted”—moved from—the original governing state to a state that allows decanting.

Importantly, the decanting process takes place outside of the judicial process that is required for reformation of trusts—providing the client with a level of privacy that cannot otherwise be obtained through the judicial process.

Decanting’s Fine Print

Trust decanting is allowed in 25 states, and 13 of the states that allow trust decanting passed the laws governing the process within the last five years. As a result, the process is relatively new and comprehensive IRS guidance has not yet been issued. Further, only two states have adopted a uniform law that has been developed on trust decanting, so the rules governing the process will vary from state to state.

The client needs to establish what he or she is trying to accomplish through the decanting process in order to choose the most appropriate state law for the particular trust. For example, only a handful of states allow a trust to be decanted without providing notice to the original trust beneficiaries (failure to provide required notices can cause the decanting to fail). Some state laws contain rules that do not allow new beneficiaries to be added to the newly created trust.

Further, only four states allow a remainder beneficiary’s trust interest to be accelerated and only six allow removal of a mandatory income interest. These provisions, along with the general tax atmosphere of the state (e.g., does the state tax the trust income and at what rate?), must be examined in order to determine the state law that is the most favorable for the client.

The trust itself can contain terms that either allow or expressly forbid future decanting. Further, the state decanting laws contain provisions regarding the trustee’s ability to decant the trust based on whether the trustee’s discretion to invade the trust principal is limited or unlimited. 

Some states require that the trustee have absolute power to invade trust principal in order to decant, while other states require only limited authority.

Conclusion

Whether to use the decanting process is only the first step in the evaluation necessary to determine the best course of action for the client—the decanting laws in the 25 states that allow the process can vary dramatically, and the advisor must carefully compare their provisions to gain the best possible outcome for the client.

See these additional articles by Professors Bloink and Byrnes:

Estate Planning: The Family Limited Partnership Strategy

The Almost ESOP Small-Business Succession Strategy