Irrevocable Trust Modification: Tips

Posted on October 15, 2019

Originally published in October 2019

This article has not been updated for current law since the date of its posting on the website. This article is not intended to provide any legal advice. Please seek advice of your professional council.

Any U.S. federal and state tax advice contained in this communication is not intended or written by the Knox Law Firm to be used, and cannot be used by you, for the purpose of: (i) avoiding penalties under the Internal Revenue Code that may be imposed upon you, or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

image of the word irrevocable from an online dictionary

IrreVOcable / iREVocable. TomATO / ToMATo. The dictionary (Google) says irrevocable means “not able to be changed, reversed or recovered; final.” Pennsylvania says otherwise.

Under the Uniform Trust Code, adopted substantially by Pennsylvania, a settlor cannot terminate an irrevocable trust and cause the assets to be returned to the settlor. Irrevocable does not mean the settlor cannot have the power to modify or terminate the trust. Nor does it mean that other parties (e.g. the trustee, beneficiaries, or the court) cannot possess the power to modify or terminate a trust.

Non-Judicial Settlement Agreements

All beneficiaries and trustees may “resolve” a matter involving a trust provided it is not inconsistent with a material purpose of the trust and includes terms and conditions that could be approved by a court.

Matters that modify a trust:

Transfer of situs;
Grant of a specific power;
Modification or termination of a trust;
Any other matter concerning the administration of a trust.
Comment to statute: * this is a “nonexclusive list”

Modification By Settlor and Beneficiaries

An irrevocable trust can be modified or terminated with consent of the trustees and ALL of the beneficiaries even if the modification or termination is inconsistent with a material purpose of the trust. If terminated, trust assets will be distributed by agreement of the beneficiaries.

Agent or other authorized representative can may consent on settlor’s behalf. Representation is required of ALL beneficiaries, including unborn and unknown.

Modification by Beneficiaries with Court Approval

ALL beneficiaries may modify a trust only if a court concludes that the modification is not inconsistent with a material purpose of the trust.

ALL beneficiaries may terminate a trust only if a court concludes that continuance of the trust is not necessary to achieve a material purpose of the trust. Trust assets will be distributed by agreement of the beneficiaries.

LESS THAN all beneficiaries can modify or terminate a trust if a court is satisfied that the non-consenting beneficiaries’ interests will be adequately protected and such modification or termination could have been achieved if all beneficiaries had consented.

A spendthrift provision is considered a material purpose of a trust.

Other Ways (Without Beneficiary Consent)

A court may modify or terminate a trust if unanticipated circumstances occur, if doing so would further the purpose of the trust. A court can modify a trust’s administrative or dispositive provisions if existing provisions impair effective administration of the trust.

If the value of the trust property is insufficient to justify the cost of administration, the trustee may terminate the trust; or the court may modify or terminate the trust or appoint a different trustee.

A court may reform a trust (even retroactively) to conform to the settlor’s probable intent.

A court may modify a trust to achieve the settlors’ tax objectives, provided the modification is not contrary to the settlor’s probable intention.

Built-In Modifications

The Trust agreement can be written to give the settlor the unilateral ability to alter any provision of the trust agreement, as long as the trust cannot be terminated and the assets returned to the settlor (i.e. revoked).

Then the issues are about the asset protection and taxation of the trust assets.

Power of Appointment Trusts, Grantor Trusts, Income Only Trusts, etc.
Settlor’s ability to modify affects the taxation of income and assets. Certain powers cause the income to be allocated to the settlor. Certain powers cause the assets to be subject to inheritance tax, or Federal estate or gift tax.
In most cases, the spendthrift provisions still protect the assets of the trust from the creditors of the settlor and the creditors of the beneficiaries.

Author: Jerome C. Wegley

Originally published in October 2019