Our two prior blogposts explored the need for regular and ongoing trust-owned policy reviews and examined methods of valuing underperforming, at-risk policies. This third post explores a potential option when a policy review uncovers a poorly drafted or obsolete irrevocable trust.
“Predictions are hard,” said former NY Yankee Hall of Famer Yogi Berra. “Especially about the future.”
Yet somehow clients, their financial advisors and estate attorneys are supposed to gaze into the future and know how newborns will turn out, what legislative, tax and carrier changes will take place, and whether a couple will stay together or divorce, remarry and potentially start second or third families. Based on this perfect seer-like wisdom, all-knowing advisors must create Irrevocable Life Insurance Trusts (ILITs) that can never be altered in any way, shape or form. Challenging? Certainly. But it’s been the status quo for years. Until now.
Twenty-eight states have either passed or are considering legislation that would allow clients to revoke (“decant”) an irrevocable trust. Even California recently conceded the wisdom of former Carmel resident Doris Day’s 1956 hit song “Que Sera Sera”1 and passed the Uniform Trust Decanting Act in 2018.
California’s new law allows trustees to modify the terms of a trust (with some limitations) without court approval or the consent of beneficiaries’ non-judicial modification). In addition, trustees can always go to court to modify an existing agreement (non-judicial modification).
Policy Reviews and the Irrevocable Trust
Trustees have a fiduciary responsibility to manage assets for the benefit of trust beneficiaries. Yet life insurance is often viewed as a passive asset by trustees. ILITs, in fact, need constant performance monitoring to ensure sufficiency of current premium payments and whether any withdrawals or loans outstanding have affected the policy over time. Failure to do so could subject trustees to an unintended breach of fiduciary duties and legal liability.
The Need for Flexibility
It used to be an irrevocable trust really was irrevocable. But the pendulum is swinging towards greater flexibility, because clients are demanding it. All too often, they will set up and fund an irrevocable trust and then demand to make changes within a matter of days.
Decanting is essentially a “do-over.” Just as one can decant wine by pouring it from its original bottle into a new bottle, leaving the unwanted sediment in the original bottle, one can pour assets from one trust into a new trust, leaving the unwanted terms in the original trust.
Decanting allows the terms of an existing irrevocable trust to be altered by creating a duplicate trust with more favorable terms and “decanting” or pouring the assets of the old trust into the new one. The decanting process may be used to correct drafting errors, removing trust ambiguities, extend the term of a trust, remove beneficiaries, change trustee provisions, or be used to combine trusts.
- Correcting drafting errors or ambiguous terms. Example: Attorney accidentally added two conflicting provisions in the trust agreement.
- Extending the term of the trust. Example: Preexisting irrevocable trust makes mandatory distributions: one-third at age 25; one-half of balance at age 30; remaining balance at age 35.
- Changing trustee provisions. Example: Preexisting irrevocable trust doesn’t have a successor trustee named and doesn’t give anyone the power to name a successor.
- Changing a support trust into a discretionary trust. Example: Preexisting irrevocable trust states “distributions can be made by the trustee for health, education, maintenance and support.”
- Changing the governing law of the trust. Example: Preexisting irrevocable trust is perfect except it requires a bad state law and doesn’t have a provision allowing a trustee to move the trust to another jurisdiction.
- Indirectly adding a beneficiary. Example: Preexisting irrevocable trust set up for spouse and descendants that cut out one of the children.
- Saving state income tax on undistributed income. Example: Preexisting California non-grantor trust for the benefit of California beneficiaries with distributions for health, education, maintenance and support and with a California trustee.
- Getting step-up in income tax basis. Example: Preexisting irrevocable trust for multiple discretionary beneficiaries; opportunity to give General Power of Appointments to use unused estate tax exemption to get new income tax basis.
- Removing a mandatory income distribution. Example: Preexisting irrevocable trust has provision distributing all income to a beneficiary.
- Accelerating a future beneficiary’s interest. Example: Preexisting irrevocable trust doesn’t include grandchildren as beneficiaries until child’s death.
If your state does not allow decanting, or is silent on the issue, some trust instruments permit the trustee to move the situs of the trust to another jurisdiction. The trustee may then adopt the laws of the new jurisdiction for purposes of trust administration.
Best Places for a New ILIT Jurisdiction
Nevada, South Dakota, Alaska and Delaware historically have been known as so-called first-tier trust jurisdictions, as all four states offer flexible, user-friendly laws. However, Nevada recently received a Total Score of 99 out of a possible 100 on the most recent Annual Trust Decanting State Rankings Chart.2
Nevada Trust Benefits at a Glance
- No state income tax on individuals, business entities, or trusts
- No state transfer taxes
- No inheritance taxes
- Protection from federal or state transfer tax or state income tax for dynasty trusts through a perpetuity period of 365 years
- Protection from personal creditors through a Domestic Asset Protection Trust
- Adoption of the Uniform Prudent Investor Act that measures performance on an entire portfolio
- Ability to convert an income interest into a unitrust interest
- Ability to establish a directed trust and use trust protectors
- Ability to appoint, or “decant”, property or assets from one trust to a second trust to take advantage of changes in law or resolve problems or issues in existing documents
To take advantage of Nevada’s laws, at least one trustee generally must be a natural person residing in Nevada; be a trust company that maintains an office in Nevada; or a bank that possesses trust powers and maintains an office in Nevada. Individuals wishing to set up a Nevada trust who may not have any individual contacts in Nevada generally use a trust company based in Nevada to serve in that capacity.
The Premier Trust Advantage
Premier Trust and Highland Capital Brokerage are sister companies, both owned by Ladenburg Thalmann Financial Services, Inc. Premier Trust, with offices in Reno and Las Vegas, administers a wide range of trusts including ILITs, Intentionally Defective Grantor Trusts (DGTs), Beneficiary Defective Inheritor’s Trusts (BDITs), grantor retained annuity trusts (GRATS) as well as other sophisticated estate planning trusts such as the Nevada Incomplete Non-Grantor Trusts (NINGS).
Premier Trust focuses on trust administration only and does not manage investments or provide legal or accounting services. This model enables clients to retain their financial advisors and other professionals. In turn, it allows Premier Trust to offer personalized, conflict-free trust administration services.
For more information about Premier Trust’s services, call 702-577-1777 or email info@premiertrust.com.
Decanting is perhaps the most underused tool in the estate planning industry, because its flexibility tends to be misunderstood and underappreciated. It’s a powerful tool that may allow correcting drafting errors or removing trust ambiguities, extending the term of the trust, removing beneficiaries, changing trustee provisions, or combining trusts. These provisions help clients to ensure their wishes will be carried out as stipulated and enables trustees to meet their fiduciary duties and legal liability.
For more information about policy reviews and decanting, email AdvancedPlanning@highland.com.