A trust is created when a person (the “Settlor”) transfers property, such as money, real estate, or stock, to another individual or entity (the “Trustee”) to hold for the benefit of specified persons (the “Beneficiaries”), subject to specified terms, and to distribute according to the Settlor’s instructions.
Trusts may be “irrevocable” or “revocable.” The terms of an irrevocable trust may be modified only in limited circumstances. The Settlor of a revocable trust may alter the terms of the trust at any time during the Settlor’s life. A revocable trust becomes irrevocable upon the Settlor’s death.
When a trust is created, its terms are based on predictions extending into the future. Yet the complexities and uncertainties of life make the future unpredictable for anyone. Unexpected changes in the stock market, real estate market, tax laws, or the lives of Beneficiaries may leave some Settlors, Trustees and Beneficiaries wishing they could modify the terms of an irrevocable trust. The current financial crisis is the type of unexpected event that may negatively impact a trust. For trusts yet to be formed, protections may be built into the trust document itself to ensure that changes can be made quickly and efficiently to address unexpected future events which might prevent the trust from carrying out its intended purpose. Fortunately, for irrevocable trusts already in existence, North Carolina law now allows the terms to be modified in some situations.
What Are the Benefits of a Trust?
Trusts are used most often for tax or estate planning purposes, including circumstances where Beneficiaries are minors or otherwise unable to manage their own affairs, where the management of trust property requires significant time and/or skill, or where the Settlor wishes to limit the Beneficiaries’ immediate access to property. In the trust document, the Settlor names the Beneficiaries and instructs the Trustee as to how the trust assets may be managed and how and when trust assets may be distributed to the Beneficiaries. For instance, the Settlor may direct the Trustee to distribute only the income generated by the trust assets or allow the Trustee to decide how much money the Beneficiaries should receive from time to time. The Settlor also may direct the Trustee to transfer ownership of all of the trust assets to some or all of the Beneficiaries at a later date.
Most trusts depend on investments such as stocks, mutual funds, or real estate to generate income for distribution to the Beneficiaries or to increase the value of the property held in trust over time. In the current economy, underperforming investments may render the terms of a trust unworkable, undesirable, or inefficient. In certain cases, the terms of a trust may be modified to avoid these and other pitfalls.
Who May Modify an Irrevocable Trust?
Under North Carolina law, the ability to modify the terms of an irrevocable trust (and the requirements for doing so) depends on the type of modification being sought and who will consent to the proposed modification. The parties who must consent to a modification may include the Settlor (if alive), the Trustee and the Beneficiaries. A modification often requires the consent of all of the Beneficiaries. Determining the identity and number of Beneficiaries of a trust is simplified when the Beneficiaries are named specifically, but trusts often refer to Beneficiaries as “heirs,” “issue,” or “children,” which may include minors or persons not yet born. In certain circumstances, North Carolina law allows parents to represent their children and unborn children. In other cases, a guardian may be appointed by the court to act on behalf of minors and the unborn to protect the interests of those who cannot speak for themselves.
When is Modification Allowed?
Irrevocable trusts are, by their nature, not meant to be modified. However, North Carolina law allows for modification of irrevocable trusts in the following situations:
- When the Settlor and all Beneficiaries consent. If the Settlor and all Beneficiaries consent, an irrevocable trust may be modified or terminated without court approval. The Settlor and all Beneficiaries may agree to modify or terminate the trust for any purpose, even for a reason inconsistent with the stated purpose of the trust.
- When the proposed modification is consistent with the trust’s purpose. If all Beneficiaries consent, an irrevocable trust may be modified if a court determines that the proposed modification is consistent with a material purpose of the trust. Even if all Beneficiaries do not consent, the court still may approve such a modification if the court finds that the interests of any Beneficiary who does not consent are adequately protected.
- When the need for modification substantially outweighs the purpose of the trust. Even if a proposed modification is not consistent with a material purpose of the trust, a court may allow the modification if all Beneficiaries consent and the court determines that the need for modification substantially outweighs the need to accomplish the material purpose of the trust. If all Beneficiaries do not consent, the court still may approve such a modification if the court finds that the interests of any Beneficiary who does not consent are adequately protected.
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When a change in circumstances occurs that was not anticipated by the Settlor. Any Beneficiary or the Trustee may petition a court for modification of certain terms of a trust where, because of circumstances not anticipated by the Settlor, the modification is needed to accomplish the purposes of the trust.
- When necessary to achieve the Settlor’s tax objectives. Many trusts are created to achieve a specific tax benefit, such as obtaining a charitable deduction or utilizing the annual gift tax exclusion for gifts made to minor children. When the terms of a trust fail to carry out the Settlor’s intended tax objective, the Trustee or any Beneficiary may petition a court to modify the terms of the trust so that the Settlor’s tax objective may be accomplished. The court must agree that the proposed modification is consistent with the Settlor’s probable intent.
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When necessary to avoid wasteful costs of administration. Unless the terms of the trust provide otherwise, if a trust contains property worth less than $50,000 and the Trustee concludes that the value of the assets is insufficient to justify the continuing administrative costs, the Trustee may terminate the trust and distribute the assets in a manner “consistent with the purposes of the trust.” A Beneficiary also may petition a court to appoint a different Trustee, modify the terms of the trust, or terminate the trust where the costs of administering the trust are unduly high in comparison to the value of the trust assets.
Conclusion
Unexpected events and changes in the law may cause trusts to operate in ways not intended or expected. An insufficient return on trust property, an inability to sell real estate, or changed circumstances in the life of a Beneficiary may prevent the trust from carrying out the Settlor’s intended purpose. For trusts yet to be formed, safeguards may be built into the trust document itself to ensure that changes can be made quickly and effectively. For trusts already in existence, North Carolina law provides the opportunity for relief in the situations described above, so that the Settlor, the Trustee, or the Beneficiaries of an irrevocable trust may be allowed to modify the trust’s terms to prevent waste and ensure that the trust’s property is put to its intended use.
For further information regarding the issues described above, please contact Jenna Fruechtenicht Butler or Michael J. Parrish.
