Under New York law, a trustee can modify an irrevocable trust in certain situations. The process, called “decanting,” permits alteration of a trust by “pouring” the existing (invaded) trust into a new trust. This gives the trustee surprising flexibility to create a new trust that will better accommodate changed circumstances, notwithstanding that the trust is irrevocable.
When to use decanting
Some of the most common situations where decanting is used include the following:
- Extending the term of the trust
Ex. Many trusts provide for “vesting” or mandatory distributions at certain milestones usually set by the beneficiary reaching a certain age. However, under certain circumstances, the trustee may want to wait to pay out funds in the trust, such as where the beneficiary has creditors. There may also be tax and estate planning considerations which warrant extension of the trust term.
- Modifying a beneficiary’s power of appointment over trust principal
Ex. The trustee wants to change the breadth of a power of appointment, which is often motivated by estate tax concerns.
- Terminating trusts that have no termination provision
Ex. The trust is no longer necessary or desired by the interested parties, but there is no way to end it using the terms of the trust. The assets can be decanted into a new trust that contains a termination provision.
- Separating trusts
Ex. Large trusts may not work if the beneficiaries are diverse (for example, of different ages) and require different investment strategies. Separating the trust into separate trusts may resolve this and make for a smoother and more efficient administration process. Additionally, decanting can be used to create a separate trust that will qualify as an owner of stock of an S corporation, or a supplemental needs trust.
- Correcting errors or ambiguous terms
- Where the method of appointing a successor trustee(s) does not work
Ex. The existing trustee wants to step down, but cannot select a successor because of the way the trust provisions are drafted.
- Tax considerations
Ex. A trustee can decant a grantor trust into a nongrantor trust, and vice versa, to take advantage of varying tax brackets; or use decanting to change the situs of a trust to a state with a lower tax or no tax.
Requirements for decanting
New York Estates Power and Trust Law specifies which trustees are authorized to decant and the rules governing decanting as follows:
- For trustees with unlimited discretion to invade trust principal:
- Beneficiaries do not have to be the same in the invaded and new trust. Beneficiaries cannot be added, but can be excluded.
- The distribution standard (power to invade) need not be the same in the invaded and new trust. For example, an invaded trust which limits discretionary distributions to those made for “health, education, maintenance and support” can be modified to a broader discretionary standard in the new trust.
- For trustees with limited discretion to invade principal:
- Beneficiaries must be same in both trusts, including the current, successor and remainder beneficiaries.
- The same standard of invasion must apply; except that if the term of the trust is extended, then during the extended term, the standard of invasion doesn’t need to be the same.
- Powers of appointment to beneficiaries must be identical.
With both types of trustees, current mandatory distribution or withdrawal rights cannot be eliminated if these rights have come into effect at the time of decanting.
Procedurally, decanting avoids costly proceedings which would otherwise be required to change the terms of the trust. The trustee doesn’t need approval or court permission. However, there are safeguards. The trustee’s decision to decant may not be contrary to the grantor’s intent and must be in accordance with the trustee’s fiduciary duties. In addition, notice must be given to all interested parties (and others) to the invaded trust. Notice must include copies of the invaded and new trusts. Beneficiaries can challenge the decision to decant and/or demand that the trustee account for his/her decision.
There are many benefits to decanting, but trustees must comply with the appropriate rules.
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This post does not constitute legal advice or establish an attorney-client relationship.