You likely have created revocable or irrevocable trusts, or a few of both, in your estate plan. Ideally, these have been properly drafted with plenty of flexibility so that they can continue to meet your wealth planning goals into the next generations. But even with the best-laid plans, unexpected changes in tax law or unforeseen life events may create a desire to modify your trust.
Modification of a revocable trust is easily done during your lifetime through a trust amendment. Modifying an irrevocable trust (including a revocable trust that becomes irrevocable upon your death) is not as easy and could require a trip to the probate court.
Sometimes, when an irrevocable trust needs modifications, it is possible to avoid the court process by “decanting” the trust. Most people are familiar with the idea of decanting wine, where you pour the contents of the original bottle into a different container to improve the flavor of the wine. Decanting a trust is similar in that it allows you to “pour” the assets from the original trust that has undesirable terms into a different trust, either a new or existing one, to leave behind the undesirable aspects of the original trust and improve the terms of the trust governing the assets. Because decanting is a private matter between the trustee and the beneficiaries, it may be a preferable option compared to asking a probate court to modify the trust.
Common Reasons to Decant a Trust
A trust may need modification for a variety of reasons that may not have been considered or foreseeable when the trust was created, including:
- Changing the trustee and other governance provisions.
- Modifying the distribution ages for remainder beneficiaries.
- Improving asset protection for the beneficiaries.
- Adding special-needs trust protections for a disabled beneficiary.
- Adding or changing a power of appointment.
- Improving tax efficiency or avoiding tax consequences at the local, state or federal level.
- Extending the trust’s duration.
Who Can Decant a Trust?
A trustee who has discretionary power to make distributions is eligible to decant a trust. Whether the trustee is a professional trustee or someone else, the trustee must carefully consider their fiduciary duties, assess the situation and understand the consequences of any changes desired. It may be desirable to confirm with the beneficiaries that they agree with the trustee’s decision to decant.
Restrictions for Decanting a Trust
Michigan law has two different statutes that authorize decanting. One statute facilitates changes to the administrative (but not distribution) provisions. Another statute allows changes to distribution provisions, but it may not be available in every situation. And not every state has decanting laws on the books, so just because decanting is allowed by statute in your state, not every trust can be decanted if the law governing administration is silent.
Examples of situations where trusts might not be eligible for decanting:
- The terms of the trust specifically prohibit decanting.
- The law of the state governing the trust does not have a decanting statute, making the authority to decant questionable.
- The trustee does not have the requisite discretion over distributions of the trust’s principal to decant and make the desired changes.
- Decanting would deprive a beneficiary of a presently exercisable right of withdrawal in the already existing trust.
- The terms of the second trust would disqualify a trust from its eligibility for special tax benefits, such as the marital or charitable deduction for estate and gift tax purposes.
- Decanting would reduce the liability of trustees, increase or change the method of compensation of the trustee, or reduce or eliminate the ability of a person holding a fiduciary power to remove a trustee.
Tax Risks in Decanting Trusts
If done incorrectly, decanting a trust can create estate, gift and generation-skipping transfer tax issues. For example, the trust may have grandfathered status related to generation-skipping transfer taxes, also known as GST taxes. Modifying a grandfathered trust could expose the trust unnecessarily to GST tax. Care must be taken to consider all the income, estate, gift and GST tax implications of decanting and making the desired changes.
Decanting Opens Up Additional Planning Opportunities
Just like no one wants a glass of wine that contains sediment from the wine bottle, no one wants to be stuck with a trust that has undesirable terms or tax consequences. When done thoughtfully, and by a professional, decanting a trust can help when a trust’s terms no longer make sense for the family’s needs or tax goals.
