Many families use irrevocable trusts to make gifts to their children and loved ones, as these trusts offer certain income and estate tax advantages. However, historically, it was very difficult and costly (sometimes even impossible) to alter the terms of irrevocable trusts. Trust decanting, on the other hand, has become a popular way to allow the terms of an irrevocable trust to be modified. Trust decanting is the process of distributing assets from one trust to a new trust with different terms for one or more beneficiaries of the first trust. Similar to the way in which wine is decanted by pouring it from its original container into another container, leaving the unwanted sediment behind, the assets from an existing trust are figuratively poured into a new trust, thereby leaving the undesirable terms in the original trust.
New York State has a decanting statute (the first of its kind) that enables the terms of an irrevocable trust to be modified by having the trustee distribute the trust assets into a new irrevocable trust for one or more beneficiaries of the initial trust.
Trust decanting is an important tool used to reform the terms of an irrevocable trust. Frequently, with the passage of time, the terms of an irrevocable trust no longer conform to tax, financial or family circumstances.
When a grantor first creates a trust, he or she makes certain forecasts regarding these various circumstances, and has the trust terms drafted accordingly. However, these predictions may ultimately turn out to be wrong. Decanting the old trust into a new trust can be an effective response to such a change in circumstances.
When to Decant an Irrevocable Trust
Obtain asset protection.
Instead of a trust mandating that distributions be made to the beneficiaries at certain ages, a trust can be decanted into a trust that continues for multiple generations. This can protect the trust assets from unnecessary estate taxes, creditors, predators and divorcing spouses.
Lengthen the term of the trust.
Many trusts require that the trust terminate when the beneficiary attains a certain age. In order to prevent a beneficiary from receiving the assets outright at a time when he or she is too young, not financially savvy enough or otherwise unprepared to receive the assets, decanting can allow for the assets to instead remain in trust.
Convert a support trust into a discretionary trust.
Many trusts allow beneficiaries to receive distributions for their health, education, maintenance and support (HEMS). These support trusts are often vulnerable to creditors, particularly divorcing spouses. Instead, decanting into a purely discretionary trust gives the trustee absolute discretion over distributions and, consequently, can protect the trust assets from creditors.
Correct drafting errors or unclear terms.
Decanting can allow for correction of drafting errors or ambiguous terms contained in the initial trust.
Change administrative provisions.
Decanting can enable provisions of a trust to be modified and modernized; for instance, to add trust protector language, to include powers to remove and replace trustees, to broaden permissible investments, and to provide for the division of responsibilities among different trustees.
Change situs of the trust.
Through decanting, a trust can be moved to a state that has more favorable income tax rates, trust laws or creditor protection statutes.
Grant powers of appointment.
Decanting can allow a power of appointment to be granted to a beneficiary, thereby enabling that individual to control and change the interests of the remainder beneficiaries of the trust.
Eliminate or add beneficiaries.
Under certain circumstances, decanting allows for the elimination or addition of trust beneficiaries.
Reduce tax liability.
A trust can be decanted to take advantage of today's large estate tax exemption and achieve a full step up in income tax basis of the trust assets upon an individual's death, thereby reducing estate and income tax liability.
Change trustee designations.
Many trusts do not name successor trustees, while other trusts designate successor trustees whom the grantor may now find undesirable. Decanting can allow for the designation of new successor trustees.
Many individuals establish trusts at different times, and ultimately, the family may have more trusts than necessary. These trusts can be combined through decanting.
Many trusts have been drafted so that all beneficiaries receive distributions from one large pot trust. A pot trust can be decanted into separate trusts for each beneficiary in order to provide greater autonomy, and to better address the beneficiaries' divergent needs and investment philosophies.
Create a supplemental needs trust.
It may not have been known when the initial trust was drafted that there would be a beneficiary with special needs. A trust can be decanted in order to preserve a beneficiary's eligibility for government benefits.
Qualify a trust as an S corporation stockholder.
A trust can be decanted in order to allow a trust to qualify as an S corporation shareholder.
Decanting can be used to modify the terms of an irrevocable trust, instead of engaging in a lengthy, costly and public court proceeding to obtain the same result.