Irrevocable trusts are often viewed as rigid, permanent components of an estate plan designed to preserve wealth, minimize taxes, and protect assets. However, as family circumstances evolve, laws change, and goals shift, these trusts may no longer align perfectly with their original purposes. Fortunately, both the terms of the trust agreement and North Carolina law can provide options for modifying or terminating irrevocable trusts.
Many estate planning attorneys assist clients with creating irrevocable trusts to transfer wealth to beneficiaries before death, while also gaining the valuable benefit of reducing estate tax liability following the client's passing. However, this comes at a cost – the client, as the grantor or creator of the trust, traditionally does not have the ability to amend the terms of the trust or revoke the trust.
In another common situation, beneficiaries often find themselves on the receiving end of assets passing from an estate or held within a formerly revocable trust (which becomes irrevocable upon the death of the grantor), leaving the beneficiaries and trustee to administer the trust in accordance with the original terms and with little room for change. The trust's terms may have been the best fit for the beneficiaries' situations at the time of the trust's creation, but circumstances may have drastically changed.
These situations are not as concrete and restrictive as they may appear at first. A trust agreement can be drafted to provide flexibility to make changes, even if the trust is irrevocable. North Carolina law also provides for several mechanisms to alter the terms of an irrevocable trust to better fit the situation at hand. Consider the following options:
Options Contained in the Terms of the Trust Agreement
If drafted accordingly, irrevocable trust agreements can include procedures for modifying the trust, providing built-in flexibility.
For example, many trusts include a Trust Protector – an individual or professional fiduciary, separate from the grantor and the trustee, who may hold the power to amend the trust terms or "decant" the trust assets into a different trust with preferable terms. The trust agreement may name a Trust Protector, or provide a mechanism for appointing a Trust Protector later, and may include limitations on who may act in the role.
Trustees also are often granted the power to decant trust assets into another trust, as discussed in further detail below. In addition, trustees can possess the discretionary power to distribute assets outright to the beneficiaries and practically terminate the trust. Such discretionary distribution authority or action mays have tax or fiduciary duty implications and must be considered carefully. The trust agreement may also grant the trustee other powers, such as the power to terminate "uneconomic" trusts, the expenses and costs of ongoing administration of which justify termination when weighed against the assets of the trust, as well as the power to grant a beneficiary a general power to appoint, or direct, where the trust property will pass.
Options Under North Carolina Law
North Carolina law provides several statutory avenues for modifying and terminating irrevocable trusts. These solutions can be further broken down into two general classes: (i) judicial mechanisms and (i) non-judicial mechanisms.
Nonjudicial Modification or Termination
A trust may be modified by consent of the grantor and all beneficiaries without the need for court involvement, if the grantor is alive and competent. Families considering such action should consult with an experienced trusts and estates attorney to assess whether there are gift, estate, or income tax consequences from this sort of modification or termination.
Decanting
North Carolina law provides that a trustee who has the discretion to make distributions of trust principal can decant, or transfer, assets of the irrevocable trust into a second trust to be administered under the second trust's terms. This second trust may provide more favorable terms, and decanting can be accomplished without court approval. There are legal requirements and restrictions regarding the permissible terms of the second trust and requirements for giving notice of the decanting to the beneficiaries of the trust. Again, consult with a trusts and estates attorney to confirm decanting is a viable option and appropriate for your situation.
Merger
Two trusts may be merged under North Carolina law so long as they have identical beneficiaries and the terms of the trust are "substantially similar." Merger of trusts is another nonjudicial option that can essentially terminate one of the merged trusts.
Judicial Modification or Termination
Judicial modification or termination, that is, modification or termination with court approval, can also be pursued under North Carolina law. First, all the beneficiaries of a trust can consent to a modification or termination and petition the court for the desired result. Absent the consent of all beneficiaries, a trust may generally be modified or terminated judicially either due to an unanticipated change in circumstances, or, alternatively, if the court determines that continuation of the trust in its current form would be impracticable. Due to the complexities involved in judicial modification or termination, these proceedings typically are reserved for more complex modifications.
Conclusion
While this article provides some insight into options to alter the terms of an irrevocable trust, anyone looking to do so should seek appropriate legal advice to determine which solution is best for them. Modification or termination of an irrevocable trust must be analyzed carefully, as there are often complex income, estate, gift, and generation-skipping transfer (GST) tax issues that arise. Care must be taken to ensure any potential modification retains tax-favorable treatment.
Although irrevocable trusts are thought to be inflexible, a range of legal strategies and tools under North Carolina law now make thoughtful modification or even termination possible in many cases. The key lies in determining appropriate solutions by identifying current family goals, tax considerations, and practical realities. By starting with a clear understanding of the trust terms and the beneficiary considerations, planners can help clients preserve the benefits of irrevocable trust planning while adapting to new circumstances.
