By Jennifer Civitella Hilario, Esq.
At the time, it was an appropriate estate planning
strategy for your family to establish an irrevocable trust. You named
your trusted friend, John, as trustee and purchased life insurance. At
your death, the trust property would be distributed outright to your
children at age 30. The strategy provided estate tax savings by keeping
the insurance out of your taxable estate and also protected the trust
property until your children were adults and mature enough to receive
Surprise, surprise, things have dramatically changed
over the past 25 years and the trust is no longer the right fit for
your family’s current circumstances. You haven’t had contact with John
for 10 years and your children’s shenanigans during college and your
son’s shaky marriage have proven to you that they should not receive
anything outright, especially their inheritance. What, if anything, can
Can I simply start over? Starting
over makes sense - cancel the insurance policy, establish a new
irrevocable trust, pick a new trustee, purchase new insurance.
However, you’re 25 years older, surely resulting in more expensive
premiums. What if something in your year medical history has made you
Can I move the assets from the existing trust to a new trust?
This is referred to as “decanting” and is possible in some
circumstances. The terms of the irrevocable trust must specifically
permit the trustees to decant the assets to a new trust. If your trust
instrument permits decanting, your trustees could move the assets into
a new irrevocable trust that will not distribute outright to your
children at age 30, but will hold the insurance proceeds in trust for
your children’s lifetimes. If the trust instrument does not
specifically permit decanting, then state law would govern. Not all
states permit trust decanting. For example, New York, Delaware and
Florida have laws that specifically permit trustees to decant trust
assets to a new irrevocable trust.
Can I move the trust to one of the decanting states?
If permitted by the trust instrument, you may be able to move the
legal situs of the trust. This often requires the appointment of a
trustee who is a resident of the desired state. Absent language in the
trust instrument, you may need to have the court approve the move. The
court may be reluctant to relinquish control. If the trust can change
its legal situs, you must make sure your circumstances fit under the
state’s decanting statute. For example, if your trust instrument
limited the trustee’s discretion to the “health, education, maintenance
and support” of the beneficiaries (i.e., a common “ascertainable
standard” restricting distributions from the trust), the trust could
not be decanted under Florida law because Florida requires the trustees
to have unlimited discretion to make distribution to the beneficiaries.
Can I have a new trust purchase the insurance policy from the existing trust?
The insurance policy is an asset, like any other, that the trustee can
buy and sell. The sale price for the insurance policy would be its
fair market value, which the company issuing the policy will provide.
How will the new trust pay for the insurance? One option is to transfer
cash to the new trust. The new trust’s trustee will then transfer the
cash to the old trust in exchange for the insurance policy. The gift of
cash to the new trust may be a taxable gift. The amount of the taxable
gift may be mitigated by your annual exclusion. The annual exclusion
allows you to gift $13,000 to an unlimited number of people each year,
e.g., a gift of $13,000 to you son and a gift of $13,000 to your
daughter will not be a taxable gift because of the annual exclusion.
Under certain circumstances, the annual exclusion may be available for
gifts made to beneficiaries of an irrevocable trust. If you gift more
than your annual exclusion, a gift tax may still not be due if you have
any remaining lifetime gift tax exemption (currently $1,000,000). If
you would prefer to avoid any gift tax consequences upon the sale of
the insurance policy, another option is to loan the money to the new
trust. The loan would be evidenced by a written promissory note and
would have a minimum statutorily prescribed interest rate. After
avoiding the gift tax traps, there are several income tax traps
awaiting the unwary client. The favorable income-tax treatment
available for insurance proceeds may be jeopardized if the policy is
purchased unless the new trust and the insured are considered the same
taxpayer for income tax purposes.
Can I modify an “irrevocable” trust?
If all else fails, an irrevocable trust may be modified (i.e.,
reformed) by the court. If there is some change of circumstances
undermining the trust’s purpose, the court may reform the terms of the
trust to protect that purpose and effectuate the intent of the settlor
(i.e., the person who created the trust). For example, if you directed
your irrevocable trust to give money to a certain charity that no
longer exists, the court may modify the terms of the trust to
distribute the money to a similar charity. Reformations may also be
granted if there has been a change in the tax law resulting in a tax
liability that the settlor intended to avoid. Unfortunately, asking
the court to reform an irrevocable trust is time-consuming and may
become expensive, especially if some of the beneficiaries of the trust
are minors, in which case the court may require a representative (a
“guardian ad litem”) be appointed on their behalf.
Needless to say, making changes to an irrevocable Trust
isn’t easy. The advice of an estate planning attorney and an insurance
advisor is highly recommended to navigate the waters when pursuing any
of these options. The good news is you have options.
Jennifer Civitella Hilario
is an associate with Tarlow, Breed, Hart & Rodgers, P.C., a Boston
law firm, and concentrates her practice in the areas of estate and tax
planning for family-owned businesses.
A version of this article appeared in Womens' Business on April 1, 2009. Please click here to view the published article.