What Should I Do With This Old Trust?

When I started practicing law in 1995, the federal estate tax exemption amount was $600,000. That was the amount of property that a person could pass to his or her descendants without any federal gift or estate taxes. And back then, the exemption amount was not transferable between spouses. If one spouse died without using his or her exemption, it was lost forever. It was common then for middle-class families to pay estate taxes.

Between 1995 and 2017, the exemption amount gradually increased, initially from $600,000 to $625,000; then to $650,000, $675,000, and so on. By 2010, the exemption amount had reached $5,000,000 per person and it became transferrable so that any unused exemption could pass to a surviving spouse.

Under the Trump tax law, officially known as the “Tax Cuts and Jobs Act,” the exemption amount doubled to $11,180,000 per person. Today, the estate tax affects less than one-half of one percent of Americans. The rest – 99.5% of all Americans – will not be subject to the estate tax.

Just a few years ago lawyers were busy helping middle-class American families minimize estate taxes, often through the use of trusts. The most common types of tax-saving trusts are credit shelter trusts, QTIP trusts, and irrevocable life insurance trusts.

Many trusts that were created years ago still exist today. But are they necessary? If not, then what should we do with these old trusts?

First, don’t be too quick to conclude that the trust is obsolete. The current $11,180,000 exemption ($22,360,000 for a married couple) is not permanent. Under current law, the exemption will revert to 2017 levels (adjusted for inflation) in 2026. Also, the estate tax is more about politics than about revenue raising, and a future Congress might very well decide that the current estate tax laws are too generous. In either of these cases, a trust that seems unneeded today might be quite useful a few years from now.

Second, keep in mind that some trusts have more than one purpose. The principal purpose of an irrevocable life insurance trust is to immunize a life insurance policy from federal estate tax. But it might also include specific benefits for different family members, like support for the spouse first and the kids later.

Third, remember that many trusts offer some protection for beneficiaries against creditor claims. Before you terminate a trust, consider whether this protection might be useful to one of the beneficiaries.

If you discuss these and other possible benefits of your trust with your estate planning lawyer and decide that the trust is no longer needed or suitable for the purpose for which it was initially intended, several options are available.

1. Most states have court procedures by which trusts can be terminated. For example, a state’s law might give judges the authority to terminate a trust if the purpose for which the trust was created has been fulfilled. If a trust was created to save estate taxes, and estate taxes are no longer applicable because of changes in the law, a judge might agree to terminate the trust. Since a judge’s approval typically is required, the cost of terminating a trust can be substantial (but still probably less than the long-term costs of keeping it intact).
2. Within the last decade or so, many states have adopted laws by which an irrevocable trust can be changed through a process known as “decanting.” Decanting is not a way to terminate a trust, but rather a way to improve an existing irrevocable trust. The trustee creates a new trust with more desirable terms and transfers the assets from the old trust to the new trust. Decanting might be used to change the conditions upon which a beneficiary would have access to the trust property, to change the administrative provisions of a trust, or to grant certain powers to the settlor (the creator of the trust), trustee, or a beneficiary. The decanting rules are strict. For instance, it usually is not permissible to eliminate a beneficiary or to add a new beneficiary, and the process requires either a judge’s approval or the beneficiaries’ consent.
3. Some trusts include provisions that allow the settlor, the trustee, a beneficiary, or someone else to modify its terms or the way it operates. For example, the settlor might have the power to withdraw the trust property and replace it with other property of equal value. Or, a beneficiary might have the power to dictate who would benefit from the trust after the beneficiary’s death; or a trustee might have the authority to move the trust from a high-income tax state to a state with no income tax. If the original trust does not include the flexibility you desire, maybe that flexibility could be gained by decanting the trust.

There is plenty of good news here. First, gift and estate taxes have gotten better for taxpayers. And second, many good options are available for handling old trusts. Please reach out to me with any questions via email or by calling 317.428.6600.