Amending irrevocable trusts
If unsinkable ships can sink, certainly irrevocable trusts can be revoked (or modified). As planners, we attempt to address every possible contingency, but sometimes assets end up in irrevocable trusts that need to be modified. Court-approved modifications are ideal, but typically they cost more and take more time than nonjudicial modifications. Fortunately, the Minnesota Trust Code allows irrevocable trusts to be modified by consent under Section 501C.0411, or through nonjudicial settlement agreements (NJSA) under Section 501C.0111.
If a settlor of the irrevocable trust is living, the modification can be done by consent or through a NJSA, both of which must be signed by all settlors, trustees and beneficiaries.1 If the settlors of the irrevocable trust are deceased, the modification can only be done through a NJSA, which must be signed by all trustees and beneficiaries.2 A "beneficiary" is defined as any individual or entity that has a present or future interest in the trust whether vested or contingent. If a charity is a beneficiary, the attorney general must consent to the modification. Absent a conflict of interest, a fiduciary can represent and bind his or her agent and a parent can represent and bind his or her minor children.3 However, a settlor may not represent and bind a beneficiary.4 If all interested persons do not consent to the modification, the modification is voidable. Each interested person should seek independent legal counsel before signing a consent to a modification or NJSA.
If the settlor is alive, the modification may violate a material purpose of the trust.5 However, if the settlor is deceased, the modification cannot violate a material purpose of the trust.6 For example, separate testamentary trusts for a settlor's three children provide each child may withdraw one-third of the assets at ages 35, 40 and 45. A material purpose of the trust is to provide for settlor's children over a period of time as they mature and priorities in their lives change. If the testamentary trusts are created under an irrevocable life insurance trust, the trusts can be modified during settlor's lifetime to provide an outright distribution. However, if the testamentary trusts were created after the settlor's death, the trusts cannot be modified to provide an outright distribution.
Evaluate whether the modification will have adverse estate, gift or generation-skipping transfer tax consequences. Because a settlor's consent alone is insufficient to modify an irrevocable trust, his or her consent to a modification will not subject assets within the irrevocable trust to be included in his or her gross estate.7
Below are scenarios where modifying an irrevocable trust is a viable option:
Appointment of successor trustee: Jack is serving as trustee of an irrevocable trust. The trust fails to name a successor trustee and Jack does not have the authority to appoint a successor trustee. Jack no longer wants to serve as trustee and the beneficiaries are unable to agree on a successor trustee. Using an NJSA, the trust is modified to authorize Jack to appoint a successor trustee. Had the beneficiaries been able to reach a unanimous agreement, they could have appointed a successor trustee without modifying the trust.8
Outdated family trust: Rose's husband passed away in 1992 when the federal and Minnesota estate tax exclusions were both $600,000 per individual. To minimize estate taxes, the husband's assets were distributed into a family trust for Rose's benefit. Rose has a limited power of appointment over the assets within the family trust. Currently, the Minnesota estate tax exclusion is $2.4 million per individual (rising to $3 million in 2020); the federal exclusion is $11.18 million per individual (rising with inflation). Although the assets within the family trust have appreciated considerably, the combined value of Rose's estate and the assets within the family trust is well below the Minnesota exclusion. Using an NJSA, the trust is modified to give Rose a general power of appointment. Upon Rose's death, the assets will receive a step-up in tax basis, and no capital gains tax will be due if the remainder beneficiaries sell the assets. The remainder beneficiaries are aware Rose could exercise her power of appointment to distribute the assets within the family trust to other individuals or charities.
Beneficiary concerns: A settlor's irrevocable trust provides upon his death, assets are to be distributed outright to his two children, Edward and Thomas, in equal shares. After the irrevocable trust is executed, Edward develops a drug addiction and Thomas is appointed as Edward's guardian. The settlor, trustee and Thomas, as an individual and Edward's guardian, consent to a modification that distributes Edward's share into a complete discretionary trust.
Moving trust situs: Minnesota is the situs and governing law of a family trust created for William's benefit. The trustee is not authorized to change the situs or governing law of the family trust. William moves to Florida to escape the cold weather and income taxes. Assets within the family trust continue to be subject to Minnesota income tax. Using an NJSA, the trust is modified to change the situs and governing law of the family trust to Florida.
The nonjudicial modification of an irrevocable trust should be a thoughtful process and used only when all interested persons consent to the modification. If an interested person is unwilling to consent, the parties should seek court approval of the modification.
Ryan Prochaska is an estate-planning attorney at Chestnut Cambronne PA in Minneapolis. He is a member of the Probate and Trust Section, and National Academy of Elder Law Attorneys, and is licensed in Minnesota and Wisconsin. You may reach him at email@example.com or 612-339-7300.
1 Minn. Stat. § 501C.0411(a).
2 Minn. Stat. § 501C.0111.
3 Minn. Stat. § 501C.0303(a)(5).
4 Minn. Stat. § 501C.0301.
5 Minn. Stat. § 501C.0411(a).
6 Minn. Stat. § 501C.0111.
7 PLR 201233008.
8 Minn. Stat. § 501C.0704(c)(2).