The Irrevocable Trust is one of the more important tools in the estate tax planning practitioner’s toolbox. Through the use of irrevocable trusts, a client is able to take advantage of important tax-savings strategies while at the same time continue to obtain an economic benefit through the terms of the trust if desired. But there is a catch. Irrevocable trusts are, well, irrevocable. Their provisions are permanent. As we all know, we live in volatile times where a client’s circumstances and expectations change and tax laws under which trusts operate are a moving target. Smart, creative drafting can never take into account every contingency a client may face during the administration of his or her trust.
Alas, New York is one of only a few states that allows for the amendment, modification or revocation of an otherwise irrevocable trust. This article will discuss the grounds and procedures available for our clients to modify or otherwise revoke entirely an irrevocable trust.
The first question one may ask is under what circumstances may I want to change or revoke my irrevocable trust? The increasing estate tax exemptions over the past few years, coupled with decreasing household wealth, may create a circumstance in which the restrictiveness of irrevocable trusts is not necessary in order to effectuate a client’s tax planning needs. In that case, a client may want to revoke a trust and take back the trust assets. We also live in a litigious society requiring one to be mindful of protecting his or her assets. There may be a need to amend a trust in order to put into place the necessary drafting safeguards to protect the trust’s assets from creditors. There are many scenarios where an amendment or revocation may be advised. So how do we do it?
The New York law provides for statutory mechanisms which allow for a trust creator to amend or revoke an irrevocable trust. Additionally, under certain circumstances, a trustee may invade a trust and transfer trust assets to a newly drafted trust with differing terms. Let’s take a look at what is required under both instances.
New York law provides that if a trust settlor obtains the acknowledged, written consent of all those beneficially interested in an un-amendable, irrevocable trust, she may amend or revoke it. With these consents, a settlor can exercise this authority to revest title to the trust in herself and otherwise alter the dispositive provisions of the trust instrument as originally contemplated. The class of individuals that consist of “all those beneficially interested” are the beneficiaries of the trust, i.e. those who receive income and principal from the trust. What if the beneficiaries of the trust are infants? Under New York case law, a minor’s consent is unnecessary if the amendment is favorable to him or her. So with the statutory winds at her back, a creator of a trust in New York can join with the beneficiaries to either revoke or amend a trust for the benefit of all.
New York also allows a trustee to alter the terms of an irrevocable trust through the back door approach of transferring trust assets to a newly drafted trust. The New York statute enables a trustee, who has absolute discretion to invade the principal of a trust for the benefit of an income beneficiary, to appoint the assets of the trust to the trustee of another trust, including a newly drafted trust, so long as the following conditions are met; (1) The fixed income interest of any income beneficiary is not reduced; (2) the exercise is in favor of the beneficiaries of the trust and (3) the appointment of the trust assets to a new trust does not diminish the trustee’s liability for failure to exercise reasonable care, nor increases the trustee’s commissions.
The advantage here is that action can be taken by a trustee, if the above conditions have been met, without the consent of the creator of the trust or if the creator is deceased. The use of this power by the trustee can be quite useful when a client is faced with an older trust which is inadequate in its creditor protection provisions. When faced with this situation, we can guide the trustee on structuring a transaction in which the trustee appoints the trust assets to a newly drafted trust which contains better safeguards against possible creditor actions.
Given the flexibility in New York to revoke and amend irrevocable trusts, we believe it would be prudent for all clients to review their trusts to ensure that they still carry out their intentions and, if circumstances have changed or if the trust was drafted poorly, to consider utilizing the above techniques.
Please contact SGR for further information.