New Power to Fix Old Trusts

Effective July 1, 2012, Virginia will join a growing number of states with what is generally referred to as a trust “decanting” statute. A decanting power allows a trustee of an irrevocable trust, generally without the approval of a court or the beneficiaries, to appoint the income or principal, or both, of the original trust to a second trust that may have different terms.

By example, this decanting power gives the trustee the ability to:

(1) Correct drafting errors in the original trust;

(2) Name a different trustee or change trustee succession provisions;

(3) Add a trust protector or trust advisor;

(4) Change the trust’s situs to another jurisdiction with more beneficial tax laws;

(5) Update administrative provisions that are no longer appropriate or useful; and

(6) Transfer assets into a second trust for a beneficiary who has become disabled and has special needs, with the second trust qualifying as a special needs trust.

The Virginia decanting statute, of course, has limitations. The second trust may not add beneficiaries who were not beneficiaries in the original trust. If the original trust limits distributions by a so-called “ascertainable” standard, then the second trust must have similar standards, with an exception for special needs trusts. A beneficiary who has only a future interest in the original trust may not have that interest accelerated to a present interest in the second trust. Further, if the original trust provides for any fixed income, annuity or unitrust benefits for a beneficiary, the second trust may not reduce those set benefits.

Virginia’s new decanting statute does contain several tax saving provisions to preserve marital and charitable deductions available under the terms of the original trust.

To exercise the decanting power, a trustee must give sixty days’ written notice of the trustee’s intention to exercise the power to the grantor of the original trust, the qualified beneficiaries, as defined in the Virginia Uniform Trust Code (other than the Attorney General), and to any person serving as an advisor or trust protector of the original trust. The trustee exercises the power to decant by a written instrument that is signed and acknowledged by the trustee. That written instrument must set out the manner in which the power is being exercised, the terms of the second trust, and the effective date of the exercise of the decanting power. A trustee or beneficiary of the original trust may bring an action in court seeking approval or disapproval of the trustee’s planned decanting.

If the original trust was required to file accounts with the commissioner of accounts, such as a trust under a will that does not waive accountings, the second trust must file accounts as well, unless a court orders otherwise.

While the decanting statute gives trustees the power to create a second trust, the statute does not require that trustees exercise this power. Specifically, the decanting statute offers protection to trustees by providing that a trustee is under no duty to exercise the power and that there is no inference of impropriety where the decanting power is not exercised.

The new decanting statute applies to any irrevocable trust, regardless of the date the trust was created, unless the trust expressly prohibits the exercise of the decanting power. Thus, in the future, Virginia trust draftsmen will need to discuss with their clients whether the trustee is to be granted the power to appoint income or principal of the original trust to a second trust under the decanting statute.

Now may be the time for trustees and beneficiaries of irrevocable trusts to review those trust arrangements to determine if any changes or corrections are appropriate, and to take advantage of Virginia’s new decanting statute.