It may seem surprising to use a wine analogy to explain a legal concept, but when discussing trust decanting, pouring wine is often a part of the conversation. When you take a bottle of wine and slowly pour the wine from the bottle into a different container, you are separating the wine from any sediments that may have formed in the bottle. This process is called wine decanting. Decanting ultimately makes the wine taste better as it removes the harsh taste of built-up sediment. Similarly, trust decanting allows a trustee to modify an irrevocable trust by “pouring” the trust assets into a new trust that has different, often more favorable terms. If a trustee has the discretionary power to distribute trust assets to and for the benefit of a beneficiary, decanting enables a trustee to use this power to dictate the terms of a new trust.
As a practitioner, hearing that a trustee can modify an irrevocable trust may sound odd, particularly if you have often reassured nervous clients that the terms of their irrevocable trusts cannot be modified. Nevertheless, trust decanting is becoming more common because it is a mechanism that addresses a persistent issue: that complete irrevocability may be too inflexible for a world that is constantly changing. Irrevocability does not take into consideration the unforeseeable circumstances that may arise during the life of a trust. Trust decanting allows for flexibility when the original trust terms no longer make sense.
To modify an irrevocable trust’s terms, a trustee must have authority. Authority may be granted in a few different ways. First, the trust document itself may have a decanting provision. From a drafting perspective, decanting provisions in a trust document should be clear as to the scope of the trustee’s authority and use of the decanting power. Adding a decanting provision to a trust can be helpful because the grantor’s intent to give the trustee flexibility is explicit, and thus the trustee’s authority to decant is less questionable.
If decanting authority is not provided in the trust document, a trustee can next look to state law. In a few states, common law provides decanting authority, but in the majority of states that permit decanting, a state statute is controlling. As of today, twenty-nine states have decanting statutes that give trustees the authority to modify an irrevocable trust under a specific set of circumstances.
If the authority to decant is not provided in the trust document, or if the state law governing the trust does not include a decanting statute, it may be possible to change the trust’s situs to a state that authorizes decanting. Certain requirements must be met, however. For example, it may be necessary to establish that the newly designated state has a substantial relation to the trust or that the application of the law of the designated state does not violate a strong public policy of the state with a more significant relationship to the trust.
Why might a trustee wish to exercise its authority to modify an irrevocable trust? Common motivations for decanting a trust include the following:
- Clarifying confusing or ambiguous trust terms
- Expanding a trustee’s investment powers
- Addressing unanticipated circumstances, such as a beneficiary with unforeseen mental or physical health issues; for example, including a special needs provision so that a beneficiary can qualify for government benefits
- Protecting trust assets from a beneficiary’s creditors by adding a spendthrift clause or modifying a mandatory distribution provision
- Adding administrative provisions
- Combining or dividing multiple trusts
- Changing a trust’s governing law or situs
- Changing the trust’s tax attributes
While each state’s decanting trust statute is different, each statute limits a trustee’s decanting power. The rationale for limiting the power is that a trustee should not be able to completely override the grantor’s intent. Each state’s decanting statute places different restrictions on the trustee—some more than others. The decanting statutes are often ranked from best to worst depending on which state imposes fewer restrictions on the trustee’s decanting power.
Depending on the state, most of the following questions are answered within each statute, serving as a guide to the trustee as to the limitations on the trustee’s authority to decant:
- Does the trustee need discretionary distribution authority in the original trust to decant?
- If the trustee is also a trust beneficiary, does the trustee still have the authority to decant?
- Can the new trust eliminate a beneficiary’s right to mandatory distributions or withdrawal rights?
- Can the trust beneficiaries in the new trust be different from those named in the original trust?
- Can the interests of the trust beneficiaries be accelerated in the new trust?
- Can the trustee alter the distribution standard that is in the original trust?
- Can the trustee grant a power of appointment to a beneficiary in the new trust?
- Is the trustee prohibited from adding tax savings provisions to the new trust?
- Is the trustee prohibited from increasing the trustee’s fee in the new trust?
- Is the trustee required to give notice to the beneficiaries before decanting?
As the list above is not exhaustive, it is important to review the state statute that governs the trust at issue to determine the limitations imposed on the trustee. Further, it is advisable to review tax considerations before proceeding with decanting, as the tax implications may be unexpected and may be a reason to not take advantage of a trustee’s authority to decant. Unfortunately, there is currently no guidance from the Internal Revenue Service on the tax implications, if any, of a trustee’s exercise of a decanting power under common law or state statute.
Wealth Docx®, WealthCounsel’s premier estate planning drafting software, offers decanting language within its revocable living trust (RLT) template. Download a sample RLT, to see what you could be drafting.