Can Irrevocable Trusts Be Broken?

trusts

CAN IRREVOCABLE TRUSTS BE BROKEN?

Written by Jeff Manley

In Part I of this blog, we set up two very real scenarios where trusts were potentially being misused based on the original intent of the grantor. As we continue, we will provide answers on what you can do if you need to break an irrevocable trust here in Arizona.

The History of Trusts

Trusts go back to the days of the Crusades. When a knight would leave England for the Holy Land, he would convey ownership of his feudal lands and the rents they generated to another party. This was done with the understanding that ownership would be conveyed back upon his return. Problems arose when the new owner didn’t return the lands, and the crusader no longer had a legal right to his property.  Recognizing the injustice of this, the king’s chancellor, over time, developed the concept of the trust, where the knight’s friend became the “trustee” who held the land “in trust” for the knight as his “beneficiary.”

Trusts and Modern Law in Arizona

Today, in general, the terms of an irrevocable trust are inviolable, never to be broken. But as life has become more complicated, the law has become more flexible to recognize that circumstances may change in ways that were unforeseeable to the grantor. As a consequence, many states, including Arizona, provide for statutory remedies to modify irrevocable trusts to reflect the grantor’s original intent. These methods include construction, reformation, modification, and decanting.

In Arizona, an attorney may use construction proceedings to ask a court to determine a grantor’s intent when the words of the trust are ambiguous or do not take into account a particular event that has occurred. Reformation involves the addition or deletion of language to correct an error in the trust instrument. Arizona statutes also allow a court to modify the terms of a trust to achieve the grantor’s tax objectives in forming the trust, since today, most trusts are formed to minimize tax consequences in addition to providing economic security.

Most strikingly, Arizona state law has codified the ability to “decant” trusts to distribute assets from an old trust to a newly created trust.  Just as one would decant wine by pouring it from its original bottle to a new bottle, an attorney can “pour” trust assets from an old trust instrument into a new, modified trust instrument with more favorable terms.  The new trust gives the trustee more flexibility to distribute assets in a way that better serves the original intent of the grantor, and under Arizona law, may even provide additional tax benefits.

Creating New Benefits

A trust can also be decanted to create new benefits, such as a special needs trust to preserve eligibility for public benefits when it may not have been foreseen that there would be a beneficiary who would require such special needs. However, Arizona law also imposes limitations on a trustee’s power to decant, including that it must remain in favor of the beneficiaries, not reduce any fixed non-discretionary income or principal paid to a beneficiary, and not adversely affect the tax treatment of the original trust.

What You Can Do

In Arizona, the power to decant may be exercised without court approval.  It is also unlikely that a beneficiary would be able to successfully oppose the exercise of the trustee’s discretion if the trustee exercises a decanting power consistently with state law.

When it comes down to it, irrevocable trusts are not so irrevocable after all. And, you are not completely powerless to stop a spendthrift heir from wasting assets or to push back the age at which a beneficiary receives a payout.  Altering the terms of a trust may be done outside of court so that the procedure remains private and costs are minimized.

If you are faced with a situation where you need to consult an estate planning attorney about breaking an irrevocable trust, contact us at May, Potenza, Baran & Gillespie. We will listen to you and help you decide what course of action may be available to you.