An irrevocable Trust is created based on the initial intent and desire of the Grantor who created the Trust. As time passes the initial purpose or circumstances concerning the Trust may have changed. This is where a Trust modification could be utilized to modify the provisions of the Trust to be more in line with what is needed currently.
Modification under Delaware law is allowed in most cases if there is a Delaware Trustee appointed who is responsible for the administration of the Trust. There are many states throughout the country that allow Trust modification, although most other state laws regarding Trust modification are not as friendly as Delaware’s laws regarding Trust modification.
I have provided three different ways to modify a Trust under Delaware law below.
Modification by Consent (12 DE Code §3342)
If the Grantor is alive, they can modify an Irrevocable Trust they’ve created under Delaware’s modification by consent law. Any provision of the Trust can be modified through this law, including material purpose items. The Grantor would work with their counsel to create the modification document which would require written consent from the Grantor, all serving fiduciaries, and all beneficiaries.
Example: Husband and wife create a Dynasty Trust for their son and their son’s future issue. A few years after funding the Trust their son had an accident and was severely impaired. He is currently receiving government benefits. It’s important that distributions from the Trust are restricted to ensure their son’s government benefits are not penalized, which was not considering in the initial drafting of the Trust agreement. The Grantor could modify the current Trust through modification by consent to include provisions in the Trust agreement to restrict any distributions that would penalize their son’s disability benefits. The modification could also include a distribution guideline for the Trustee to follow.
Non-Judicial Settlement Agreement (12 DE Code §3338)
This modification method can be utilized if the Grantor is alive or deceased. A Non-Judicial Settlement Agreement allows for trust modification outside of court as long as the modification does not violate the material purpose of the Trust and includes terms and conditions that could be approved by the DE Court of Chancery. A Non-Judicial Settlement Agreement would require written consent from the Grantor (if living), all serving fiduciaries, and all beneficiaries.
Items that could be modified under a Non-Judicial Settlement Agreement include:
(1) The interpretation or construction of the terms of the trust;
(2) The approval of a trustee’s report or accounting;
(3) The direction to a trustee to refrain from performing a particular act or the grant to a trustee of any necessary or desirable power. This would include the ability to appoint additional fiduciaries, an investment or distribution advisor, or a Trust protector;
(4) The resignation or appointment of a trustee and the determination of a trustee’s compensation;
(5) The transfer of a trust’s principal place of administration;
(6) The liability of a trustee for an action relating to the trust.
Example: The grantor of a Revocable Trust assigned an interest in a closely held company to his Trust. When he died the assets held by his Revocable Trust were to be split and added to two separate Trusts created for his children. The closely held company was not able to be sold, so its ownership interest was split and assigned to the Trusts held for the two children. The Trustee appointed to these Trusts was not comfortable having investment discretion over the closely held company. The beneficiaries advised the Trustee that they would prefer to take over the investment responsibility for the closely held company. A Non-Judicial Settlement Agreement was created to add a Special Holdings Advisor who would have responsibility for the closely held company to be held by the Trusts. The children were appointed as the Special Holdings Advisor for each of their Trusts.
Decanting – Trustee’s authority to invade principal or income in trust (12 DE Code §3528)
This modification method can be utilized if there are many changes that need to be made within a Trust. The Trustee of the existing Trust would create a new Trust with more favorable provisions. The Trustee would then pour over, or decant, the assets from the current Trust into to a newly created Trust. The Trustee would be required to have discretionary authority over the principal of the existing Trust. This approach generally does not require approval from any parties associated with the Trust other than the Trustee exercising their discretionary authority. Most Trustees do request releases from all parties associated with the Trust before proceeding with a decanting modification. It’s important to note that there are limitations to what can be included in the resulting Trust and also tax considerations that will need to be reviewed before utilizing this modification approach.
Some examples of modification that can be made using this approach would be as follows;
(1) Current beneficiaries can be excluded in the new Trust Agreement, although the new Trust cannot exclude remainder beneficiaries or add any additional beneficiaries.
(2) A current beneficiary can be granted a general power of appointment in the new Trust. See example below.
(3) A beneficiary’s right to distributions can be limited in the new Trust, although the distribution standards cannot be expanded beyond a standard created in the original Trust.
(4) This modification approach can also be used to change the administrative provisions of a Trust similar to what can be modified through a Non-Judicial Settlement Agreement. The new Trust can include an investment or distribution advisor, trust protector, or appointment of successor Trustees.
Example: John created two separate Trusts for the benefit of his daughters Sarah and Jane. Jane had two children and Sarah had no children when the Trusts were created. John applied his full GST Exemption to the gift made to Jane’s Trust. It was initially thought that Sarah would not have any children although she had two children many years after her Trust was created and funded. Sarah advised that she will not be taking any distributions from her Trust and intends on her children benefiting from the Trust when she’s no longer alive. Her children would be considered skip-beneficiaries and any distributions received by her children would be subject GST tax. The distribution provisions of Sarah’s Trust permit the Trustee to invade the principal of the Trust. The Trustee created a new Trust and transferred the assets from the existing Trust to this Trust. The new Trust provided Sarah a general power of appointment over the assets of the Trust, which would make the Trust assets includable in her Estate at her death. Sarah’s children will now receive the assets of the Trust with no GST tax implications at her death. This modification could potentially provide Sarah’s children significant tax savings at her death.
These modification approaches are great tools for older Trusts that might need to be updated to be in line with today’s more modern Trust laws. These approaches are also frequently utilized for the addition of an investment advisor, distributions advisor, or Trust Protector in Trust Agreements where these roles were most likely not initially thought of or needed. Finally, to utilize these approaches the Trust must have a Trustee that is located in Delaware. Where the Trust was created is not important, as long a Delaware Trustee is in place.
If you should have any questions or want to discuss this further, please do not hesitate to reach out to me. If you are considering modifying an existing Trust utilizing the techniques listed above you should discuss this with your counsel.
Keith Al-Chokhachy, CFP®, CTFA, ATFA
Vice President / New Business Development Officer
Phone: (302) 510-6027 / Email: firstname.lastname@example.org
*The posts expressed are views of FSTC and are not intended as advice or recommendations. For informational purposes only. FSTC does not offer tax, legal, or investment advice, professional counsel should be sought for tax or legal advice.