Key Takeaways:
- A strategy known as “decanting” could potentially allow you to alter the terms of an irrevocable trust.
- Decanting can be used to remove a beneficiary, to split one trust into two trusts, and for other purposes that align with multigenerational wealth preservation.
- Tax complexities and other factors make it important to get comprehensive advice when decanting a trust.
Irrevocable trusts are a cornerstone of many successful families’ broader wealth management plans—and with good reason. Such trusts can potentially provide immediate tax benefits, reduce estate taxes, and protect assets from creditors while ensuring proper stewardship across generations.
Of course, to obtain these benefits, you must relinquish control over the assets placed in the irrevocable trust.
But what happens when circumstances change in ways that could put an irrevocable trust in conflict with its original purpose and the grantor’s intent? Perhaps there’s been a significant tax law change—or maybe there’s been a major development in a beneficiary’s life. In such instances, an irrevocable trust’s rigid “set in stone” characteristics could suddenly threaten the family’s wealth preservation strategy.
The good news: An irrevocable trust may not be as unchangeable as it initially appears.
A strategy known as “decanting” could potentially allow you to modify the terms of an existing irrevocable trust. Many of our affluent client families use this often-overlooked approach to improve their existing trusts when needed, helping to maintain their wealth transfer objectives without creating entitlement issues.
Here’s a look at what trust decanting involves—and how to determine if it’s appropriate for your family’s situation.
From One Trust to Another
Very often, irrevocable trusts function exactly as intended—in part by protecting against the risk that someone could alter a trust’s terms in unwanted ways after the grantor’s passing. However, these trusts can sometimes benefit from thoughtful modification—and that’s where trust decanting becomes valuable.
In wine terminology, decanting involves carefully pouring wine from its original bottle into a new vessel. The purpose is to transfer the liquid while leaving behind unwanted sediment. The result should be a pure-tasting wine without impurities.
With trusts, the concept is similar. Trust decanting aims to “pour” assets from a trust that has become outdated (or contains a mistake) into a newly created trust with improved terms—so beneficiaries receive the intended benefits while avoiding undesirable aspects of the original trust. Think of it as a strategic trust refinement to better serve future generations.
Decanting has been utilized by sophisticated estate planning attorneys for decades. While it’s becoming increasingly common, trust decanting isn’t permitted in all states. Additionally, rules and regulations regarding decanting vary significantly depending on jurisdiction. Some strategies discussed below may be feasible in certain areas but not others. Consulting with experienced professionals who understand both financial planning and legal implications is essential.
Reasons to Decant
There are numerous situations where decanting an irrevocable trust makes strategic sense for family wealth preservation:
- Remove a beneficiary. If a beneficiary develops a substance abuse problem or otherwise demonstrates they may not be responsible with inheritance, decanting can modify the trust to better protect family assets while still providing support in appropriate ways. This helps avoid the entitlement issues that often arise with outright inheritance.
- Combine multiple similar trusts. Sometimes, family members become beneficiaries of several trusts with similar terms. Decanting can merge multiple trusts, reducing administrative costs and streamlining oversight across generations.
- Split one trust into several. Conversely, a single trust might have multiple beneficiaries with diverse financial needs. That trust can be decanted into separate vehicles more customized to each beneficiary’s situation. For example, siblings with different risk tolerances can implement their respective investment approaches through separate trusts.
- Convert from a support trust to a discretionary trust. Support trusts typically pay only for a beneficiary’s education, health, and similar expenses. If a trustee wants the assets to fund other purposes, the trust can (in some states) be decanted to allow for discretionary distributions. Furthermore, support trusts may not fully protect against beneficiaries’ creditors—decanting into a discretionary trust can potentially strengthen asset protection.
- Move the trust to a different state. Changes to state laws regarding taxation, creditor protection, and other issues can negatively impact trusts. Decanting can transfer a trust governed by unfavorable laws to a new trust based in a state with more advantageous rules. This aligns with our philosophy of tax efficiency and maintaining family wealth across generations.
- Establish a special-needs trust. If a beneficiary develops a disability or special need, the trust can be decanted into a special-needs trust that potentially allows qualification for government benefits while maintaining family support.
- Fix drafting errors or ambiguities. Many trusts contain vague language or actual drafting mistakes. Decanting provides a mechanism for trustees to correct these issues without court intervention.
How to Decant
Decanting requires expertise and careful consideration. First, determine whether decanting is possible in the state where the trust was established, as not every state permits this strategy.
If decanting is allowed under that state’s laws, the trustee typically needs to notify relevant parties (though notification requirements vary significantly). A new trust addressing the reasons for decanting is drafted. Once created and signed, the trustee can transfer assets from the old trust to the new one and begin administration.
What if the trust exists in a non-decanting state? First, review the existing trust document for any decanting provisions. If none exist, check whether the trust allows the trustee to change the trust situs—the state whose laws govern the trust.
- If so, the trust can be relocated to a decanting-friendly state.
- If not, explore whether a nonjudicial settlement agreement statute allows changing the situs before decanting. Court petition for trust reformation is another option, though potentially expensive.
For families currently establishing trusts (whether revocable or irrevocable), we often recommend including decanting provisions in the agreement. This provides flexibility that may help avoid court involvement if decanting becomes necessary later.
Watch Out for Unwanted Tax Consequences
Navigating the trust decanting process requires coordinated tax and legal expertise. One critical consideration is avoiding unwanted tax consequences. Generally, it’s advisable to keep the grantor uninvolved in the decanting process. If decanting doesn’t change the grantor’s rights and interests in the trust principal, there should be no estate tax issues. However, trust assets could be included in the grantor’s taxable estate if the IRS determines the grantor was too involved in decanting or if the new trust gives the grantor powers they didn’t have under the original trust.
Conclusion
Trust decanting is not a DIY project. The rules are complex and vary significantly across jurisdictions. If you’re considering this strategy to better align your trust with your family’s generational wealth objectives, consult with experienced wealth managers and trust attorneys who understand both the technical aspects and your family’s broader financial goals.
At Almega Wealth Management, we work closely with estate planning attorneys and administrative trust companies to ensure that multigenerational wealth transfer strategies remain effective even as circumstances change. By integrating our tax expertise through Almega Tax LLC, we provide comprehensive guidance on both the financial and tax implications of trust modifications.
A well-executed decanting strategy can help ensure your family’s wealth continues to provide for future generations without creating entitlement issues—allowing your legacy to support education, opportunity, and success for generations to come.
Bryan Wisda is a CERTIFIED FINANCIAL PLANNER and NAPFA-Registered Financial Advisor. He is the President of Almega Wealth Management. To schedule an exploratory call with Bryan, please click here.