Changing the Unchangeable - Are Irrevocable Trusts Bulletproof?
How unchangeable are irrevocable trusts? At first glance, an irrevocable trust should be just that . . . . irrevocable, unchangeable, unalterable. In truth, most irrevocable trusts might be more flexible than meets the eye. Over the past 40 years, irrevocable trusts served as an excellent wealth planning tool that provided two benefits: allowing individuals to transfer wealth to loved ones while also reducing estate taxes by removing the assets funding the irrevocable trust from the grantor's gross estate. When the estate tax exemption was significantly lower, estate planning attorneys could implement an irrevocable trust as part of a larger estate plan. Today, with an estate tax exemption of $11.58M for individuals and $23.16M for couples, irrevocable trusts are not as useful or prominent as they once were because estate tax planning is rarely a part of the estate planning process. But what about all those old irrevocable trusts that were created to avoid the estate tax exemption? Can beneficiaries and the settler adjust the terms of a trust to fit their estate planning needs today?
In a word: yes. There are three ways, under Michigan law, to modify an irrevocable trust:
Modification by Consent
The most efficient and cost-effective way to modify an irrevocable trust is through a "Non-Judicial Settlement Agreement." Michigan's Estates and Protected Individuals Code ("EPIC") specifically provides for modifications to a trust by "[all] interested persons . . . with respect to any matter involving a trust." Trustees and beneficiaries can work together to modify the terms of the trust to fit those interested parties' needs.
Modification by Court Order
EPIC also provides the court with the power to modify an irrevocable trust. However, Trusts created before April 1, 2010, are subject to Michigan case law rather than EPIC; the case law and EPIC both provide for court modification in certain circumstances. Under MCL 700.7410 et seq., a court can act in the following ways: A court can terminate a trust if the trust is unlawful or the value of the trust is too small to continue administration, a court can modify the terms of the trust to achieve the trust creator's tax objective, and a court can modify a trust to conform with the settlor's intent. Suppose a non-judicial settlement is not available as an option to modify a trust. In that case, the trustee and beneficiaries can look to the courts in these limited circumstances to modify the trust.
Modification by Decanting
Another alternative that beneficiaries can use to modify the terms of a trust is through what is known as "Trust Decanting." Like pouring a fine wine into a decanter, trust decanting is the process of "pouring" a trust's assets into a new trust by a trustee.
There are several motivations as to why a Trust decanting may be a practical choice for a trustee and beneficiaries to modify a trust. Decanting can help correct drafting errors or fix adverse trust provisions. It can help address a beneficiary's unanticipated circumstances, such as a beneficiary's debt problems, wealth, or health. Further, a decanting can be useful for tax planning purposes, such as triggering the grantor trust tax rules.
On its face, an irrevocable trust might appear to be an insurmountable challenge that leaves the beneficiairies in an less than optimal position. However, there remains options on how to best handle such circumstances. If you have an irrevocable trust that you are unsure of how to manage, reach out to your estate planning attorney to see what options are available for you.
