Irrevocable trusts are often designed to last for generations; however, situations occur where circumstances change, tax laws change or the terms of the trust simply become outdated, inappropriate or not suited to a family’s evolving goals.
Contrary to popular belief, irrevocable trust terms can be changed and modernized if handled properly. While not without limits, you can modernize the terms of an irrevocable trust.
First, clarify the reasons behind the changes you want to make. Second, understand your options to execute the changes consistent with the fiduciary duties of the trustee. Third, make sure you identify all potential tax implications and follow through on the necessary administrative steps.
Clarify your need for changes
Modernizing the provisions of a trust could be required for a range of factors. Most commonly, what may have made sense five, 10 or 20 years ago might not make sense today.
Some primary non-tax reasons to modify an irrevocable trust include:
- To correct drafting errors
- To address changed family circumstances
- To provide for a special needs trust
- To change the trustee or successor trustee
- To prevent a vacancy in the trustee
- To allow greater flexibility around the trust investments
- To change the governance to align with where the trust is being administered
Often overlapping with any non-tax reasons, common tax-related reasons to modify an irrevocable trust include:
- To move a trust to a state with lower state income taxes
- To grant, remove or change a power of appointment to include or exclude assets from a beneficiary’s estate for tax purposes
- To convert a grantor trust to a non-grantor trust, or vice versa
- To address provisions for handling distributions from IRAs (individual retirement accounts)
- To qualify a trust to own stock in an S corporation
Once you’ve identified the reason to make a change, your next step is to understand your options to do it.
Consider how to approach changes
Depending on the governing law, there may be multiple ways to execute a change to the trust terms.
Start with these steps:
- Carefully review the terms of the trust. The first step in modernizing an older irrevocable trust is to carefully review the trust document and understand its provisions. Sometimes, the trust terms may provide a means for change on their own — for example, the trustee or trust protector may be permitted to make certain changes. Other times, the trust terms may facilitate or prevent certain techniques.
- Evaluate the governing laws. Trust laws vary from state to state. In many cases, the laws may have changed since the trust was created. Most states allow modification of an irrevocable trust under certain conditions, either with court approval or without. Several states, including New York, California and Delaware, also have decanting statutes, which allow the fiduciary to distribute assets from one trust into another.
- Consider a trust modification. In some states, you may be able to modify the existing trust without court involvement by obtaining the consent of all the beneficiaries. For example, in California, if the settlor of the trust is alive and willing to consent to the changes and all the beneficiaries are also willing to consent, you can modify the trust without court approval. In other situations, a court would have to approve the modification. This typically involves additional time and expense, but in some cases, it can be relatively straightforward.
- Consider a non-judicial settlement. Some states allow for a “non-judicial settlement agreement,” which is simply a specialized form of an agreement among the parties of a trust. Non-judicial settlement agreements often don’t require court involvement.
- Consider decanting. If modification either is not possible or will require court approval, consider decanting. Decanting is a process that allows you to transfer the assets from an old trust to a new trust with updated provisions. The concept is the same, although state law differs on what changes you can make to the first trust. Decanting can be a good option when you want the existing trust to go away.
Understand tax considerations
After you know how to make your change, make sure you’ve evaluated all the tax consequences. It’s important to think through the tax consequences you may be seeking with a change, as well as tax consequences you may not be focused on. There are several that you should take into account, including:
- Estate and generation-skipping transfer taxes. Will the assets of the trust be included in a beneficiary’s estate for tax purposes? Depending on the level of the beneficiary’s personal assets, that may be either a good or bad result. Be mindful of making a change that might subject assets to estate tax unless that is the purpose of your change. Assets subject to estate tax receive a step-up in income tax basis, so if the beneficiary’s estate is below the estate tax exemption ($13.61 million for an individual in 2024, but scheduled to be cut approximately in half in 2026), inclusion in their estate can have a positive tax result. If the beneficiary’s estate is over the exemption, inclusion is a bad result. In addition, make sure you know the trust’s generation-skipping transfer tax status, and have your legal counsel give close attention to the impact of any change.
- Income tax. If you are decanting, consider whether the new trust will be a different taxpayer than the original trust. Decanting is often ignored for income tax purposes, but you need to be careful if transferring liabilities between the trusts and if you are significantly changing the interests of beneficiaries. With modification, consider whether the new terms will change how income will be reported or taxed between the trust and its beneficiaries. Also, consider how the changes will affect the trust’s state income tax responsibilities.
- Gift tax. A modification or decanting of a trust typically does not result in a gift, but you need to pay attention if the action makes major changes to the interests of the beneficiaries. It is possible for the shifting of interests to result in a gift that could trigger a gift tax.
Follow through and continue to review
Once you’ve made a change, make sure you follow through. All parties should be aware of the change. If assets are to be transferred, ensure those transfers occur and titles are updated. If there’s a change in tax status or reporting, the trustee should be coordinating with the trust’s tax adviser.
Sometimes much effort is put into a change, but the parties fail to follow through and the practical aspects of a change never occur. Eventually, the lack of follow-through may result in the need for yet further changes.
The longer an irrevocable trust survives, the greater chance that it may need to be revised to reflect changed circumstances. As a beneficiary, trustee or even the original grantor of an irrevocable trust, it’s a good idea to review the terms of your trust every few years to ensure its original purpose remains viable.
As tax laws and state laws change and your family evolves, changes to the terms of your trust may make sense. Though not necessarily easily changed or amended, it is possible to modernize your irrevocable trust with the right legal guidance.
