A closer look

Making Changes to
Irrevocable Trusts

Woman reading documents on can an irrevocable trust be changed
In brief
  • For decades, long-term irrevocable trusts have been an important means for families to transfer wealth to multiple generations in a tax-efficient way. 
  • Despite the benefits of long-term trusts, over time, a key provisions on everything from administration to investments to beneficiary distributions may need to be adjusted to serve the trust creator's goals or address circumstances that could not have been foreseen at the trust's creation.
  • In some cases, trust decanting — "pouring" the assets from an older trust into a newer one - may be an effective way to update those provisions. 
  • It is important to decant carefully so as not to jeopardize the tax efficiencies, asset protection, and other benefits of the original trust. And with rules varying from state to state, trust situs is another important consideration

In passing the landmark Tax Reform Act of 1986, Congress aimed to limit the ability of a handful of America's wealthiest families to pass money tax-free in trusts from generation to generation in perpetuity. Yet the generation-skipping transfer taxes included in the Act created potential tax inefficiencies for many people  hoping to leave money to their grandchildren. Anything above the estate tax exemption could be taxed twice: first, when passing to the children, and second, when passing from children to the grandchildren. At the current tax rate of 40%, that could mean an effective tax rate of 80% by the time an inheritance reached the grandchildren. 

Generation-skipping trusts (GSTs) have offered many families of wealth a way to give more efficiently

Generation-skipping trusts (GSTs) have offered many families of wealth a way to give more efficiently. By bypassing estate tax in the child's estate entirely, GSTs enable individuals or couples to leave money directly to the next generation. 

As a result, these long-term irrevocable trusts have become increasingly popular. One tradeoff, for grantors, is that they give up the power to revoke or amend the trust once it is formed. Yet because lives and families are constantly in flux, the longer a trust survives, the greater chance that it may need to be revised to reflect changed circumstances. Fortunately, irrevocable and unamendable don't mean immutable. It is possible, when necessary to change an irrevocable trust. 

This, in turn, raises a vital question: How does one change provisions in an irrevocable trust without violating its terms and potentially losing the long-term tax protections it provides? Simply dissolving the trust and starting over could eliminate the tax and asset protection benefits that made the original trust so valuable. In some cases, an answer may line in decanting — so named because it involves pouring the assets from an existing trust into a new one with more favorable terms. While decanting has become an increasingly popular option in recent years, it must be done with care and is not the answer for every situation.

GSTs and the Estate Tax Exemption

The current gift and estate tax exemption ($11.7 million for individuals and $23.4 million for couples in 2021 if the law isn't changed under the Biden administration) has effectively eliminated estate taxes for most American families. Yet the exemption is set to revert at the end of 2025 to pre-2018 levels of $5 million for an individual and $10 million for a couple (indexed for inflation), and Congress could potentially lower the exemption before then. 

And even at the current level, GSTs may help families pass along more wealth and create greater asset protection. Say, for example, a grandmother wants to leave money to a grandchild. If she passes the money outright to her child, the gift will count against her child's exemption when the gift passes to the grandchild at the child's death. By using the protective wrapper of a GST, the grandmother ensures that money can ultimately be passed to subsequent generations without diminishing her own child's exemption.

There may be tax reasons for changing a trust — for example, changing its location to a state with more favorable laws.

Why Change a Trust?

There are a number of potential reasons for changing a trust. The first and simplest category involves administrative changes, such as correcting a drafting error, modernizing certain provisions, or dividing or merging a trust to reduce administrative costs. 

Other changes are more complex, involving how the trust assets are distributed. These might involve eliminating a beneficiary or, as the needs of various beneficiaries evolve, switching from a pot trust to separate share trusts. A pot trust (in which all beneficiaries receive money from the same set of assets) might be appropriate when the beneficiaries are young. But as they grow older, meeting their separate needs may require different methods of investing the assets. 

In some cases, a family may want the trust to hold special assets, such as concentrated stock positions, significant real estate holdings, or a family business, and appoint a direction advisor — a separate fiduciary assigned to manage them. This involves switching to a directed trust, which relieves the trustee of fiduciary responsibility over those assets. A trust may also need changing if a beneficiary is having problems with creditors, going through a difficult divorce or struggling with substance abuse. Finally, there may be tax reasons for changing a trust — for example, changing its location to a state with more favorable laws. These changes, however necessary, may be difficult to make within the existing trust — thus decanting or another method may be called for.

Ways to Change a Trust

Depending on the changes needed, there are a variety of approaches to consider:

Exercise of general trust powers. Depending on the terms of the trust, a trustee may already have the authority to make important changes, such as changing the trustee or the situs of the trust, dividing a trust to suit the needs of different beneficiaries, delaying distributions, changing governing laws, selling trust assets, or making other important administrative changes. Because it involves relatively minimal time and expense, exercise of general trust powers is the preferred option where practicable. 

Nonjudicial modification. More complex changes may be enacted within an existing trust and without the involvement of a court, assuming that all interested parties — including trustee, grantors, and beneficiaries — agree to the changes. Assuming everyone agrees, it may even be possible to change a trust in ways that run counter to its original purpose. Yet gaining everyone's approval may be difficult, especially if the change eliminates a beneficiary or alters his or her benefits in case of substance abuse problem or other issue, or where there are minor or disabled beneficiaries for whom no other party can consent on their behalf. Nor is the Internal Revenue Service necessarily bound to accept such agreement. 

Judicial modification. Changing a trust when all parties do not agree or cannot be represented by others requires a court's approval. In addition to the time and expense involved, judicial modification involves the risk that a judge or those appointed by the court to represent minor or disabled beneficiaries may disagree with the changes. And going to court opens up aspects of the trust to public viewing, thus negating one of the key advantages of trusts — privacy. 

Decanting. This approach is often considered to be the ultimate amendment power because it enables a single party, usually the trustee, to fundamentally modify certain terms of a trust without the consent of other trust parties (as in nonjudicial modification) or of a court (judicial modification). As such, it may be possible to make changes in a way that maintains privacy and avoids adverse tax consequences. 

A primary advantage of decanting is that it does not require the consent of beneficiaries

The Decanting Revolution

As the name implies, decanting essentially involves "pouring" the assets from an existing trust into a new one with more favorable terms. In the decanting analogy, unwanted or outdated trust provisions are often compared with sediment that accumulates over the years at the bottom of a bottle of fine wine. 

Trust "sediment" may mean terms that lock its managers into an investment style that no longer pertains to current markets, forces managers to invest the same way for all beneficiaries, even as their needs have diverged, or that generate unnecessary administrative costs by requiring the trustee to adhere to outmoded processes. As originally written, the trust terms may interfere with a necessary change for tax efficiency, such as switching from a grantor trust to a non-grantor trust (or vice versa), or moving to a state that doesn't subject the trust to state income taxes solely because the grantor or trustee is located there. 

A primary advantage of decanting is that it does not require the consent of beneficiaries — an important consideration for issues such as substance abuse, where the beneficiary might resist a change limiting his or her access to distributions. Even when beneficiaries do agree to the changes, there may be tax reasons to have the trustee act alone. For example, if an older beneficiary actively agrees to give up some benefits in favor of a younger beneficiary, the IRS might view that as a gift, potentially triggering gift taxes. 

Just as a bottle protects wine from being spoiled, a trust provides a "protective wrapper" around the assets. The central challenge is to decant carefully enough to maintain the original trust's advantages. Without careful steps to ensure those assets will remain protected, they could be exposed to adverse tax consequences, and if a beneficiary is going through a divorce, being sued, or facing other pressures, the assets could be in jeopardy. 

Choosing the right state in which to decant is a vital part of the process, not just for the potential tax advantages that certain states offer over others, but to help ensure that the decanting safely protects the assets.

Location, Location

For all the advantages of decanting, the rules governing the process are not fully settled at a federal level and vary considerably from state to state. Therefore, choosing the right state in which to decant is a vital part of the process, not just for the potential tax advantages that certain states offer over others, but to help ensure that the decanting safely protects the assets.

As of this writing, 29 states have decanting statutes, and others are considering enacting them. While the language of these statutes varies, the general idea is that a trustee's discretionary power grants him or her the authority to create a new trust and to distribute trust assets from the original trust to the new one. In a landmark 1940 court case in Florida, the Phipps family — the founders of Bessemer Trust — first established decanting as a viable process (see, "The Phipps Case: A Common Law Precedent"). Other important cases have occurred in New York and Iowa.

The Uniform Trust Decanting Act, dating to 2013, offers guidance to states on standardizing decanting rules nationwide. Yet some states, such as Delaware, have more favorable trust codes, including those related to decanting. Decanting in Delaware from a state with high income taxes offers families the opportunity to protect trust assets from those taxes. Delaware irrevocable trusts with out-of-state beneficiaries pay no separate Delaware income tax on distributions. 

In certain cases, some states provide that if a trust has a distribution standard for health, education, maintenance, and support for beneficiaries, the new trust must maintain the same standard. Conversely, Delaware allows for the new trust to further restrict the purposes for distribution. 

By the same token, moving to some states could pose risks. For example, several states — including Delaware, Nevada, Wyoming, Alaska, and others — have strong "creditor protection" provisions, making it hard for outsiders to gain access to trust assets. Decanting to a new trust in a state without such protections could put the assets at risk to creditors and inclusion of the trust assets in the beneficiary's estate. 

The Phipps Case: A Common Law Precedent

Though decanting has become increasingly popular in recent years, the practice was first established in a 1940 Florida court case involving the Phipps Family, the founders of Bessemer Trust. 

Margarita Phipps, a resident of Palm Beach County, had started a trust several years earlier for the benefit of her children and grandchildren. As the family grew, her husband, John S. Phipps, serving as individual trustee, and the Palm Beach Trust Company, serving as corporate trustee, wanted to include the spouse of one of the grown children as a beneficiary. In order to accomplish this, they decided to place the assets from the original trust into a new one. 

While language of the original trust gave John S. Phipps "sole and absolute discretion"1 over the trust assets, he  and the corporate trustee believed that court decisions in their favor would encourage federal tax authorities to recognize the validity of the new trust in maintaining the same asset protection offered by the previous one. 

To gain approval, the trust essentially sued itself (Hence, Phipps v. Palm Beach Trust Company) in a series of cases. In 1940, The Florida Supreme Court ruled that, given his absolute discretion in administering and disposing the trust, "there can be no question of the power of the individual trustee to create the second trust estate for the benefit of the class named in the original trust indenture."1 The case set an important precedent for other states and is a key reason that Florida remains one of the friendliest states for decanting. 

Expert advisors with deep experience in the financial, legal, and tax implications of trusts and the rules in various states can help you decide whether decanting could help you meet your objectives

Limitations of Decanting

The first order of business when considering decanting is to do no harm. Perhaps the greatest risk involves trusts formed before the Tax Reform Act of 1986. These historic trusts contain exemptions from modern generation-skipping transfer taxes, thanks to grandfathering — and trustees and lawyers must take special care to avoid running afoul of IRS rules and potentially destroying that protected status. 

As a rule, purely administrative changes and other modifications that don't alter the quality, value, or timing of any beneficial interest under the trust are unlikely to result in loss of exempt status. But special care must be taken with actual or constructive additions to a grandfathered trust through the beneficiary's release, exercise or lapse of a power of appointment — which could result in the trust assets being subject to generation-skipping transfer taxes. 

Even with newer trusts, it's vital to consider all of the federal and state tax and legal consequences before taking action. Expert advisors with deep experience in financial, legal, and tax implications of trusts and the rules in various states can help you decide wither decanting could help you meet your objectives, and help ensure that, like fine wine, your trust provisions get better with age.

Bessemer's tax and trust and estate professionals are here to help you and your advisors consider whether trust adjustments could help your family transfer wealth efficiently as life and circumstances change. 

Case Study: Creating Two Trusts Out of One

A family in California sought to change several provisions in a longstanding generation-skipping trust (GST). They wanted to protect family assets from unnecessary dissipation and create investment flexibility for future generations. By moving the trust from California to Delaware, the family was able to provide greater asset protection under Delaware's more favorable laws, minimize exposure to California's fiduciary income tax, create flexibility in the investment portfolio, and retain control over investment decisions through a direction adviser. 

In order to attain their objectives, the administrative law of the trust needed to change from California to Delaware. But there was a hurdle: The original trust terms contained no provisions for changing the trust's administrative law. Bessemer helped the family gain approval from a California court for a change of the trust's administrative law. Delaware, with its trust flexibility and favorable tax laws, was a natural choice. This change allowed the trust assets not otherwise generating California source income to minimize exposure of the trust to California fiduciary income tax, thereby creating greater tax efficiency. The trust became a directed trust, which allowed for more flexibility in the types of investments that the trust could hold. The trust was divided into separate trusts so that the trust could tailor the investments to each beneficiary's needs. By moving the trust to Delaware, the trust also gained greater asset protection from creditors and divorce through the application of Delaware's more favorable asset protection laws. 

  1. Phipps v. Palm Beach Trust Co., 196 So. 299 (Fla. 1940)
  2. When forming a trust, it's very helpful to include a provision enabling the trustee to change situs. When trusts (often, older ones, as in this case) do not include such language, a court must grant permission. This detracts from the key advantage of privacy that trusts offer.

Past Performance is no guarantee of future results. This material is for your general information. It does not take into account the particular investment objectives, financial situation, or needs of individual clients. This material is based upon information obtained from various sources that Bessemer Trust believes to be reliable, but Bessemer makes no representation or warranty with respect to the accuracy or completeness of such information. Views expressed herein are current only as of the date indicated, and are subject to change without notice. Forecasts may not be realized due to a variety of factors, including changes in economic growth, corporate profitability, geopolitical conditions, and inflation. Bessemer Trust or its clients may have investments in the securities discussed herein, and this material does not constitute an investment recommendation by Bessemer Trust or an offering of such securities, and our view of these holdings may change at any time based on stock price movements, new research conclusions, or changes in risk preference.

Zeigler Laura

Laura K. Zeigler

Senior Fiduciary Counsel

In this role, Laura is responsible for working with clients and their advisors to develop practical and efficient wealth transfer plans, and for guiding the firm on fiduciary issues.