Estate Planner Nov-Dec 1998
Your estate plan needs to meet your current goals and objectives yet provide flexibility to change if your goals change. For example, while irrevocable trusts may be advantageous for tax purposes, if you don’t build in flexibility, issues arising in the future may be difficult to deal with. For maximum flexibility you need to consider the extent of restrictions you want, your desire for certainty, and your tolerance for tax risks. An irrevocable trust cannot be changed, so what happens if a change in your circumstances makes the trust less desirable?
A disclaimer is one tool you can use to build in flexibility, but only if you plan for it. If a beneficiary does not want to receive the trust assets, he or she can disclaim them. If done within nine months of the vesting of the beneficiary’s interest, the assets will pass to someone else as if the beneficiary had never received them. However, if the beneficiary directs where the assets will go, the disclaimer will be treated as a gift for tax purposes. Therefore, successfully using disclaimers means you need to plan ahead when you initially prepare the trust.
When might a disclaimer be useful? If the trust’s beneficiary already has substantial assets, he or she may want to use a disclaimer to keep the assets out of his or her estate.
To provide your beneficiaries with the flexibility to deal with situations such as these, when drafting your trust, consider who should receive the benefit if your beneficiary disclaims it. You can state in the trust document that if the trust beneficiary disclaims the payout, it should pass to the secondary beneficiary.
Exercise Powers of Appointment
One of the most effective ways to alter an estate plan after death is through the exercise of powers of appointment. A power of appointment allows a beneficiary to direct the trustee to distribute trust assets to certain individuals (objects of the power), either outright or in a new trust.
This can be useful if the beneficiary does not need the trust assets and would like to pass those assets on to someone else, such as a child or grandchild. With a power of appointment, he or she can direct or appoint those trust assets to any one or more objects of the power.
As the trust’s creator, you can grant the power of appointment to one of the trust’s beneficiaries. If you make the power too broad, however, it may be deemed a general power of appointment. This will cause adverse tax consequences for the beneficiary. To avoid this, you should restrict powers of appointment so that they cannot be exercised in favor of the beneficiary, the beneficiary’s estate or creditors of either.
Typically, a “limited” power to appoint will be exercisable in favor of your descendants, but sometimes it can be broader and allow for exercise in favor of people or charitable organizations other than the beneficiary, the beneficiary’s estate or creditors of either.
Exercise Discretionary Trust Provisions
Another means of providing flexibility in an irrevocable document is through discretionary trust provisions. For example, a trust can allow distributions to or for the benefit of the beneficiary according to a broad best interests standard, providing the trustee wide latitude to distribute funds that the beneficiary can use as he or she wishes. Essentially, you can add flexibility to a trust by drafting provisions that:
- Allow greater discretion to an independent, yet carefully chosen, trustee;
- Permit the primary beneficiary to have a certain amount of control over the selection of trustees;
- Permit the beneficiary to exercise either broad or limited powers of appointment — either during life or on death; and
- Permit the primary beneficiary to control trust investments.
Reformation By Court Proceedings
One definitive way to change a trust after it has been signed is through a court reformation proceeding. While this alternative can be uncertain and expensive, it may achieve the desired result. You can initiate court reformation proceedings over an ambiguity in the document as well as under some other circumstances. If you seek a court reformation, make sure you avoid unwanted tax consequences. For example, if the trust is exempt from the generation-skipping transfer (GST) tax, a reformation that affects the quality, value or timing of any powers, beneficial interests, rights or expectancies of a beneficiary provided under the terms of the trust can be deemed a “modification,” which can cause the trust to lose its GST tax exempt status. But, many ways to reform will not cause loss of the exempt status.
Other Noncourt Trust Reformation Techniques
Certain situations allow a trust to be reformed without resorting to a court proceeding. You can grant a trustee certain powers to amend the trust agreement, to create a new trust for a trust beneficiary and to distribute trust property to that new trust. Also, certain state laws allow reformation of a trust pursuant to agreement of all trust beneficiaries without the involvement of a court. In all cases, you need to judiciously use these noncourt reformation techniques to avoid any adverse tax consequences to the parties involved.
Help Is Available
Creating an irrevocable trust may seem to limit your flexibility once the trust has been implemented. But, by carefully drafting the trust, or by using tools available to you after the trust is signed, you can have your cake and eat it too. We would be pleased to assist you in establishing a trust that will meet your needs.