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Scott Small

Financial Planning > Trusts and Estates

Irrevocable Trusts: More Revocable Than You Might Think

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Despite its name, an irrevocable trust is not set in stone. Changes can be made to many of the provisions as a result of the Uniform Trust Code of 2000 and other federal and state legislation.

All of that has prompted an increasing number of high-net-worth investors to amend their irrevocable trusts.

“You can pretty much alter many of the provisions of [an irrevocable] trust as long as it doesn’t alter the material purpose of the person who set up the trust,” Scott Small, trust counsel at Fiduciary Trust International, tells ThinkAdvisor in a recent interview.

Trusts used to be limited in duration, but as a result of legislation over the past few decades, some have been created to last as long as 1,000 years.

“You can’t predict what’s going to happen [in general, even during far shorter terms], so there needs to be a way to be somewhat flexible and nimble,” Small says.

In the interview, he explains some ways that irrevocable trusts can be changed, such as replacing a trustee and settling a family dispute by “decanting” the assets in the original trust into a new, revised one.

Before joining Fiduciary Trust International, Small was a senior vice president of estate services and senior regional fiduciary manager at Wells Fargo Wealth & Investment Management, as well as senior vice president of trust services at Wells Fargo Private Bank in Radnor, Pennsylvania. Earlier, Small was with BNY Mellon Wealth Management as director of specialized fiduciary services.

In the phone interview with Small, who was speaking from his Radnor office, he details how having an irrevocable trust will help ultra-high-net-worth clients deal with an upcoming tax blow when a law enacted during the Trump administration sunsets at the end of 2025, according to Small.

“Estate planning is a tax game, as the federal transfer tax system has been called,” he remarks.

Here are highlights of our conversation:

THINKADVISOR: How irrevocable are irrevocable trusts?

SCOTT SMALL: Laws in many states have changed over the last 20 or 30 years to do away with “the rule against perpetuities.”

That meant a trust could last only for a certain amount of time. Now you can have trusts for 360 years or, in some states, 1,000 years.

The problem is that you can’t predict what’s going to happen [in general]. So there needs to be a way to be somewhat flexible and nimble. 

There was always some flexibility; but with the promulgation of the Uniform Trust Code [of 2000], you started seeing more and more folks amend their irrevocable trusts.

Just about every state has adopted some form of the Uniform Trust Code.

What’s an example of how a change can be made?

One way is with a family settlement agreement. This is where the beneficiaries get together and decide that something needs to be changed.

You can pretty much alter many of the provisions of a trust as long as it doesn’t alter the material purpose of the person who set up the trust.

What are examples of specific things you can change?

Most modern-day trusts contain provisions whereby beneficiaries or the trustees themselves have the ability to remove and replace trustees if the trustee isn’t performing well.

However, some states say you can remove a trustee only because of acts of malfeasance — if they committed fraud, say.

Poor investment performance probably isn’t enough. It’s got to be a breach of fiduciary duty.

What’s another example?

Early termination due to size: The trust has been spent down over years or generations; so it’s now a relatively modest amount.

Assuming there is agreement among all the current beneficiaries, trustees and the qualified beneficiaries — who would benefit if the current beneficiaries are gone — you may terminate the trust without seeking court permission.

You do that through a nonjudicial settlement agreement.

The family can do a split between the current beneficiaries and the qualified beneficiaries.

What’s a more complex scenario?

We’re working on one right now: In 1980, a man created a trust for his daughter. When she dies, the beneficiaries will be her children.

We’ve realized that the trust has a great deal of low-basis stock in it. So a lot of capital gains have occurred over 40 years. Almost $2 million of appreciated assets are in this trust, and you can’t take advantage of the step-up in basis with the current arrangement.

So we got everybody’s agreement to amend the trust to give the daughter, who is in her 70s, a general power of appointment.

For generation-skipping transfer-tax purposes, that makes her the transferor instead of her dad, who died in 1981.

Further, at her death, it allows those assets to take advantage of the step-up in basis.

As a result, when she dies, the family is going to save $400,000 in taxes, which would have been the capital gains tax on $2 million.

When it comes to financial planning, how else can irrevocable trusts be useful?

There’s a method of pouring one trust into another, or decanting. A friend of mine calls that “diffusing disaster.”

It’s a trust law concept used to settle a dispute, which has developed widely in recent years. 

Let’s say some provision in a trust is ambiguous, and one side of the family is fighting the other about it.

The trustee can decant, or distribute, all the assets of the trust into a new trust without getting the court involved. Therefore, it’s not an expensive thing to do.

With all this flexibility to change an irrevocable trust, why would someone establish one? Why not just set up a revocable trust instead?

The big reason is coming up in two years.

For people that have a combined net worth of $1 million or a couple of million dollars, it’s not an issue. It concerns couples with $15 million and up. 

Advisors should talk with such clients about this the sooner, the better — and bring in an attorney.

What’s coming up, then?

The “estate tax cliff”: A tax law that Mr. [Donald] Trump’s administration passed sunsets in 2025. This means that the applicable exclusion amount, which for 2024 is $13.61 million, will drop to the amount it was back in 2012, which was $5 million indexed for inflation.

Most experts think it’s going to be about $7 million per person.

So the ability to transfer wealth — $14 million per person, $28 million per couple — will be effectively cut in half.

That’s where these fancy irrevocable trusts come in because they can leverage the exclusion amount.

How?

If you have a concentration of low-basis assets, you might want to use a charitable remainder trust to leverage the gifts that you make to your loved ones. 

Or if a large part of your wealth is in the form of a personal residence or vacation residence, you might want to create a qualified personal residence trust.

This is an irrevocable trust that holds just the real estate, and you retain the right to live there rent free for a term of years and the right to have it come back into your estate if you die during that term.

So because the rule sunsets in 2025, speed is of the essence. Isn’t it?

Right now, we’re in a use-it-or-lose-it scenario. 

Broadly, the country’s big wealth transfer, especially for baby boomers, has begun. In light of that, what should the generation who holds the assets be doing?

They need to plan and get in to see their attorneys to make sure their wealth is being transferred as effectively as possible.

Once you get past the basic questions of estate planning: Who do you love? What do you have? Where do you want it to go? Estate planning is a tax game, as the federal transfer tax system has been called.


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