Reformation/Modification and Decanting

In many cases, it may be helpful to reform, modify and thus modernize many existing irrevocable trusts. Alternatively, it may be beneficial to decant from one existing trust to a newly drafted trust, provided the trustee has the power to distribute assets. Modifications, reformations and decanting of a trust have gained popularity as a result of modernized trust laws, and are often utilized by a client because of changes in family circumstances and/or a desire to change trust administration.

Reformation and Modification of an Existing Trust:

The ability to modify/reform a trust can generally be inserted into a trust document at its creation. Reformations/modifications can also take place without language in the trust document by appointing a trustee in a state like South Dakota. This is followed by a petition to the court by the trustee or a majority of beneficiaries to reform/modify the trust.

Reformations and modifications are generally easiest when both the grantor and the beneficiaries are alive and all agree with the reformation/modification. Further, unborn beneficiaries can be represented pursuant to South Dakota’s powerful virtual representation statutes.

Reformations/modifications can be done if circumstances, which were not anticipated by the grantor, have arisen and if the modification of the trust would substantially further the trust or the purpose for creating the trust. Additionally, the reformation can generally be accomplished in order to conform the terms due to a mistake of fact or law and the grantor’s intent can be established. Further, in order to achieve the grantor’s tax objectives, the terms of a trust instrument may be construed or modified in a manner which will not violate the grantor’s probable intention.

As previously mentioned, reformations/modifications in South Dakota are quick (2-14 days) and inexpensive ($2,500), as well as private. However, South Dakota trust situs is necessary to utilize South Dakota’s laws and courts for a trust reformation/modification. Consequently, it is important to review the trust document to see if SDTC can be appointed as trustee. Once appointed as an administrative trustee, SDTC can petition the court for the reformation.

Trustees or beneficiaries might wish to modify an irrevocable trust to:

• Change the administrative terms of the trust to ensure the trust provides the proper tools to its fiduciaries for the best management of the trust(e.g. changing a delegated provision to a directed trust structure with investment and distribution committees/advisors)
• Improve the trust’s governance structure
• Improve tax provisions
• Save state income taxes
• Add flexibility regarding appointment of trustees and other fiduciaries
• Add a trust protector
• Change the governing law applicable to the trust
• Change dispositive provisions (e.g. remove term stating 1/3 of principal at age 25, 1/3 at age 30, and 1/3 at age 35 and make discretionary for asset protection purposes (family as distribution committee directs SDTC as to distributions)
• Modernize an outdated trust agreement

Please see: “Decanting: A Statutory Cornucopia” by Rashad Wareh and Eric Dorsch, Trusts & Estates magazine, March 2012.; also “Trust Remodeling” by Rashad Wareh, Trusts & Estates magazine, August 2007.

Decanting a Trust

Decanting is the process of appointing trust property in favor of another trust i.e. distributing property from an old trust to a new trust. Some trusts provide the trustees the power to decant in a trust document. A few states, like South Dakota, have also enacted favorable decanting statutes. A trust generally permits trustees to pay trust principal over to one or more beneficiaries, which is called the power to invade the trust. If the trustee has any discretion over income or principal, South Dakota’s decanting statute permits a South Dakota trustee to pay all trust property to another trust for the same beneficiary/beneficiaries. Choosing the most appropriate decanting statute depends on the nature of the trustee’s discretionary authority. South Dakota’s top rated decanting statute provides a lot of flexibility for trust remodeling.

Reformation and modification both result in keeping the original trust, whereas “decanting” results in the transfer of assets from an existing trust to a newly created South Dakota trust. The process involves the appointment of a South Dakota trustee to an existing trust, then the South Dakota trustee would decant (i.e., distribute trust assets) to the newly drafted South Dakota trust. Consequently, it is important to review the trust documents to see if SDTC can be appointed as a trustee to provide the necessary nexus to South Dakota for the decant.

Decanting is may be helpful with the following situations:

• Changing the governing law provisions of a trust;
• Modifying the administrative provisions;
• Modifying powers of appointment;
• Adding spendthrift protections;
• Adding or removing grantor trust provisions;
• Amending trustee succession provisions, removing or replacing a trustee;
• Segregating higher risk assets;
• Combining trusts for greater efficiencies;
• Separating trusts to allow investment philosophies to be “fine tuned” for beneficiaries;
• Saving on state and local taxes;
• Reducing distribution rights for Medicaid eligibility planning purposes;
• Correcting drafting errors;
• Responding to changed circumstances;
• Extending the term of a trust;
• Assisting beneficiaries with disabilities;
• Correcting a scrivener’s error or ambiguity;
• Qualifying a trust as a qualified subchapter S trust, a QDOT, an IRA conduit trust, etc.;
• Combing, segregating or otherwise improving irrevocable life insurance trusts (ILITs) and credit shelter trusts;
• Decanting a beneficiary’s share of a trust to a supplemental needs trust in order to preserve or obtain eligibility for public benefits; and
• Dynasty trusts, although less common, are also excellent candidates for decanting.

Source: Thomas E. Simmons, Decanting and Its Alternatives: Remodeling and Revamping Irrevocable Trusts, 55 S.D. L. Rev. 253, 255 (2010).

Restatement Combined with Reformation/Modification:

One alternative to decanting is to reform and modify the trust in a South Dakota court, as previously discussed, and at the same time restate the trust utilizing South Dakota law. The resulting restated trust would utilize South Dakota law for interpretation, construction, validity and administration. This can be done on a case by case basis. Consequently, decanting does not require court involvement, whereas reformation/modification and restatement would generally require court involvement. However, sometimes court involvement is desired. Any court matters in South Dakota involving trusts are automatic total seal in perpetuity.

South Dakota Decanting Statute:

South Dakota’s decanting statute is one of the top rated statutes in the country, because it allows for broad authority for decanting a trust. South Dakota requires only that a trustee have “discretionary authority” over income or principal (without requiring that authority to be “unfettered” or “absolute”). Any trustee discretion over income or principal is appropriate. Also, South Dakota’s list of acceptable beneficiaries of the new trust is worded in the disjunctive.

Additionally, the language of the South Dakota statute permits the new trusts into which old trusts are decanted, on a case by case basis, to have different beneficial interests. Furthermore, it would even allow formerly contingent beneficiaries to become current beneficiaries and share equally (or pursuant to a different allocation) with those beneficiaries who previously were the only current beneficiaries.

Trustee notice to the beneficiaries of the decant is optional in South Dakota . The South Dakota statute does restrict a trustee’s exercise of the decanting authority in that the trustee must take into account the purposes of the trust from which property is to be decanted, the terms of the new trust and the consequences of the decanting.

The costs for decanting are also very reasonable, if SDTC is appointed.