M How to Unlock an Irrevocable Trust for Maximum Advantage

How to Unlock an Irrevocable Trust for Maximum Advantage
How to Unlock an Irrevocable Trust
for Maximum Advantage
by Steven J. Oshins, Esq., AEP (Distinguished) and Neil Schoenblum
M
any of our clients fail to set up irrevocable trusts either because they don’t understand how much
flexibility can be drafted into the trust or because their advisor isn’t aware of the available options. Likewise, those of our clients who have already set up irrevocable trusts, but then changed
their minds about some of the choices made, often don’t realize that many of the provisions can be fixed
or improved. The fear of the word “irrevocable” often causes people to fail to act and therefore fail to take
advantage of opportunities that are available.
Why Revoke or Amend an Irrevocable Trust?
One reason to revoke or amend an irrevocable trust is that circumstances have changed. For example, the
settlor of the trust might have lost his job, gotten sued or divorced, had a health issue or simply misjudged
economic conditions that may not have been contemplated at the time the trust was established.
It is also very possible that the settlor will change his mind about how much to benefit each of his heirs,
including the possibility that an heir may have a problem that wasn’t contemplated when the trust was
initially designed. What happens if the settlor no longer wants to give anything to an heir? What happens
if the heir is going through a divorce and the trust was established in a jurisdiction that doesn’t protect the
trust’s assets from the divorcing spouses of the beneficiaries? What happens if the settlor and the trustees
no longer get along or if a trustee is found to be dishonest?
In addition, many trusts are drafted with little thought towards protection for the beneficiaries. For example, it is very common for a trust to make mandatory distributions of one-third of the assets to the
beneficiary upon reaching age 25, one-half of the balance upon reaching age 30 and the balance upon
reaching age 35. This type of staggered distribution scheme sounds good in theory, but in reality it fails to
consider the asset protection, divorce protection, bankruptcy protection and estate tax savings that most
of our clients would want if given the option to have their trust drafted accordingly. Many of our clients,
after discovering that their trusts could have been better-drafted, want to make changes which typically
are forbidden since the trusts are irrevocable.
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Provident Trust Group | 8880 W. Sunset, Suite 250 | Las Vegas, Nevada 89148 P (702) 479-3849 E [email protected]
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How to Unlock an Irrevocable Trust for Maximum Advantage
Furthermore, many trusts are set up in a state that has a state income tax that could have been avoided.
Although the trust is irrevocable, are there options available to move the trust to a jurisdiction where state
income taxes can be avoided?
New vs. Preexisting Trusts
Designing a new irrevocable trust so that modifications may be made in the future and where common
drafting errors are avoided from the outset is much simpler than modifying a preexisting trust since it is
easier to start from scratch than to have to work through the various issues that exist when trying to modify a preexisting irrevocable trust. Making adjustments to a preexisting trust are much tougher because the
ability to make changes is generally limited by the trust agreement itself and applicable state law.
Modifying a Preexisting Trust
The first step in modifying a preexisting irrevocable trust is to look at the trust agreement. This will help
determine what options are available.
Trust Protector/Independent Trustee Power to Amend
Does the trust agreement give a trust protector or independent trustee the power to amend the trust
agreement? Some trusts provide for this, while many others do not. And if a party does have the power to
amend the trust agreement, there are often restrictions within the applicable provisions that would preclude amending the trust agreement for certain purposes. This often is a result of the trust draftsman trying to provide flexibility within the document, but yet not give the trust protector or independent trustee
so much power that items that the settlor would not have wanted to be changed can be changed.
Beneficiary Power of Appointment
Does a beneficiary have a power of appointment? The advisor should check the document to determine
whether a beneficiary has a power of appointment which gives that beneficiary the power to make changes going forward. That beneficiary cannot have a power of appointment that would allow the beneficiary
to make changes for himself, his estate, his creditors or the creditors of his estate unless inclusion of the
trust assets in the taxable estate of the powerholder was intended.
If the beneficiary has a power of appointment, then the beneficiary can exercise that power to change the
trust terms in just about any way for the more remote beneficiaries. For example, many irrevocable trusts
set up by one spouse for the benefit of the other spouse give the beneficiary spouse a power of appointment to allow the beneficiary spouse to make changes among the beneficiaries. The spouse can reduce a
beneficiary’s share, remove that share altogether, change how the beneficiary receives the share or do just
about anything else, except as may be limited by the terms of the power of appointment.
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Provident Trust Group | 8880 W. Sunset, Suite 250 | Las Vegas, Nevada 89148 P (702) 479-3849 E [email protected]
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How to Unlock an Irrevocable Trust for Maximum Advantage
The settlor’s children generally also have a similar power of appointment. It gives each of them the power
to change how their descendants receive their assets. Very often, the grandchildren are young or even unborn when the trust is established. Therefore, planning for the ability to adjust their shares is an important
flexibility to build into the trust agreement.
Trust Protector/Independent Trustee Power to Add Beneficiaries
Does the trust agreement give the trust protector or independent trustee the power to add beneficiaries?
If so, then, depending upon the class of beneficiaries that may be added to the trust, there may be a way to
make adjustments to the ultimate shares by simply adding beneficiaries and then having the distribution
trustee make a larger distribution to a beneficiary that was added to the trust after the trust was established.
Sometimes the settlor’s spouse can be added as a discretionary beneficiary. Sometimes the spouse is already
a discretionary beneficiary. In an emergency, if the settlor needs access to the trust but isn’t a beneficiary,
distributions can be made to the settlor’s spouse who can then “share” the distributions with the settlor.
If the settlor wants to benefit someone who wasn’t an initial beneficiary of the trust, then if the trust allows for
it, the trust protector or independent trustee can add that beneficiary and then the trustee can make distributions to that new beneficiary or modify the ultimate distributions so that the new beneficiary gets a share.
Choice of State Law - Decanting
Depending upon the choice of state law provision in the document, there may be opportunities to change
the terms of the irrevocable trust by taking advantage of flexible laws that many states now have. The current trend is to modify an irrevocable trust through decanting. Decanting a trust involves setting up a new
trust with different terms for those beneficiaries and then having the trustees distribute the trust assets
from the original trust into the recipient trust.
A minority of states allow decanting. If the state where the irrevocable trust is domiciled does not allow
decanting or has limited decanting statutes, then the advisor should look at the choice of law provision in
the trust agreement and determine whether the trust allows the trustee to move the trust to a different
jurisdiction. If so, then it’s simple to find a more favorable jurisdiction, name a trustee or co-trustee in the
new jurisdiction, and then move the trust. After moving the trust, the trustee can decant the trust and
make modifications that may be desired.
Decanting a trust can solve most problems. This area of the law is still undeveloped and many advisors
have not yet utilized it. However, there are significant opportunities for an advisor to become familiar with
decanting in order to be able to explore more flexibility for their clients who could use decanting, but
might not have been introduced to it.
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Provident Trust Group | 8880 W. Sunset, Suite 250 | Las Vegas, Nevada 89148 P (702) 479-3849 E [email protected]
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How to Unlock an Irrevocable Trust for Maximum Advantage
If the original trust does not allow the trustee to move the trust to another jurisdiction, then the trustee will
need to check local law to see what the default law is if the trust is silent. One option if local default laws
do not help is to have a local attorney petition the court to obtain approval to move the trust to a different
jurisdiction. After obtaining court approval, the trust can be moved to the new jurisdiction where it can
then be decanted.
Creating New Irrevocable Trusts - Flexibility
Newly-designed irrevocable trusts should be designed with as much flexibility for change as possible. The
trust scrivener should be aware of the possibility that changes will be desired in the future and should draft
accordingly. Following are some tips that should be considered in designing new irrevocable trusts.
1. Use a “floating spouse” as a beneficiary. The “floating spouse” is defined as the person the settlor is married to from time to time. This means that if the settlor and settlor’s spouse get divorced, then if the
settlor gets remarried, the new spouse is a discretionary beneficiary in place of the former spouse. This
can be extremely valuable if the settlor ever needs to access any of the trust assets since it is easy for the
trustees to make a distribution to the settlor’s spouse who can then share it with the settlor. This provision is recommended even if the settlor isn’t currently married since it opens up an interesting potential
option in the future.
2. Give a trust protector or independent trustee the power to amend the document for certain purposes.
There are often potential modifications that couldn’t have been anticipated when the trust was established. Many settlors will be glad to have added this flexibility to their trust agreements.
3. Give the primary beneficiary a power of appointment. This is a power to amend the document for purposes of future beneficiaries. If the particular fact pattern is such that this would be too much control for
the primary beneficiary, then consider giving the power of appointment with the caveat that it may only
be exercised with the written permission of the settlor’s close friend. The friend can make sure the power
is exercised in a manner with which the settlor would agree and serve as the watchdog.
4. The settlor should retain the power to remove and replace trustees. Many trusts fail to provide this
power even though the tax code and IRS Rulings certainly allow for it. Be careful to design it so that it
conforms to the tax laws. An advanced estate planner will be able to draft accordingly. There are many
existing irrevocable trusts where the trust scrivener did not realize that the settlor could retain this much
power and therefore the trust was drafted in such a way that the settlor lost the indirect control over the
transferred assets.
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Provident Trust Group | 8880 W. Sunset, Suite 250 | Las Vegas, Nevada 89148 P (702) 479-3849 E [email protected]
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How to Unlock an Irrevocable Trust for Maximum Advantage
5. Carefully select the jurisdiction in which to domicile the irrevocable trust.
a. There are many jurisdictions where trusts are not subject to state income taxes in certain circumstances. This should be considered when determining where to domicile the trust.
b. There are many jurisdictions where the settlor can be a discretionary beneficiary of the trust, thereby creating what is commonly known as a Domestic Asset Protection Trust. Even better, since there
is often a concern about which state law applies to a Domestic Asset Protection Trust, consider
instead using a Hybrid Domestic Asset Protection Trust. This is a trust in which the settlor isn’t a
discretionary beneficiary initially, but where the settlor can be added into the trust as a discretionary beneficiary by the trust protector. This fixes the issues that often exist with respect to a regular
Domestic Asset Protection Trust. The ability to potentially be added as a discretionary beneficiary
at a later date is often the difference between a client moving forward with the planning versus
doing no planning as a result of the “what if I need it back?” concern. The leading Domestic Asset
Protection Trust jurisdictions seem to be Nevada, South Dakota, Ohio, Tennessee and Alaska as
ranked by the most recent Domestic Asset Protection Trust State Rankings Chart at http://www.
oshins.com/images/DAPT_Rankings.pdf.
c. Also consider domiciling the irrevocable trust in one of the leading Dynasty Trust jurisdictions. A
Dynasty Trust is an irrevocable trust that continues for as long as applicable state law allows. This
provides for estate tax savings and creditor protection for multiple generations. The leading Dynasty Trust jurisdictions seem to be South Dakota, Alaska, Nevada, Tennessee and Ohio as ranked
by the most recent Dynasty Trust State Rankings Chart at http://www.oshins.com/images/Dynasty_Trust_Rankings.pdf.
Steven J. Oshins, Esq., AEP (Distinguished) is an attorney at the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada, with
clients throughout the United States. He is listed in The Best Lawyers in America®. He was inducted into the NAEPC Estate Planning Hall of Fame® in 2011 and was named one of the 24 Elite Estate Planning Attorneys in America by the Trust Advisor. He has
authored many of the most valuable estate planning and asset protection laws that have been enacted in Nevada. He can be
reached at 702-341-6000, ext. 2, at [email protected] or at his firm’s website, www.oshins.com.
Neil Schoenblum, JD, LLM, is a Senior Trust Officer at Provident Trust Group in Las Vegas, Nevada. At Provident, he is principally
responsible for overseeing fiduciary administration, with a focus on personal trust relationships and client service. Neil is a graduate of Northwestern University, Cornell Law School, and the LL.M. in Estate Planning Program at the University of Miami. He can be
reached at 702-788-9918, at [email protected], or at Provident’s website, www.trustprovident.com.
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Provident Trust Group | 8880 W. Sunset, Suite 250 | Las Vegas, Nevada 89148 P (702) 479-3849 E [email protected]
u trustprovident.com