Estate and gift tax planning frequently involves the use of irrevocable trusts that are established during life. Moreover, establishing an irrevocable trust at death is a very common estate planning tool to assist in the protection of wealth for the benefit of family and other beneficiaries. Some trusts are designed to hold assets perpetually into the future. Since Nebraska allows trusts to last “forever” due to the abolition of the so-called rule against perpetuities, it is important for trusts to include provisions that address changes in circumstances. One way to allow a Trustee or other named “fiduciary” to make changes to a trust is by including a so-called “decanting” provision.
Despite the benefit of including such a provision, not all trusts administered in Nebraska or governed by Nebraska law include a decanting provision. Thus, most modifications to trusts require the execution of a nonjudicial settlement agreement and/or the involvement of a court of competent jurisdiction to approve the proposed modification.
In an effort to modernize Nebraska’s trust law, and to provide another effective way to modify a trust, the Nebraska legislature recently adopted the Nebraska Uniform Trust Decanting Act (“Act”). The Act is effective on November 13, 2020.
What is Decanting?
Under the Act, “decanting” is a means by which a Trustee is able to exercise a discretionary distribution power to transfer or “decant” assets of the trust into an entirely new trust. When discussing a “decanting” under the Act, the current trust is designated as the “first trust” and the Trustee appoints or transfers all or a portion of the first trust’s assets to a “second trust.” The second trust will usually contain many, and in some cases most, of the provisions of the first trust but will contain the desired modifications. For example, if a person creates an irrevocable trust for the benefit of a young child and the Trustee is authorized to make distributions for that child’s best interests, but later it is determined that the child has a disability or impairment that necessitates that the child take advantage of means-based government assistance such as Medicaid, then the Trustee could decant the assets of the child’s trust (the first trust) into a new special needs trust (the second trust) that would not disqualify the child from receiving government benefits. This is just one example when it might be advantageous for the Trustee to decant trust assets. Another example might be a trust that was established to last during a child’s life, and at the child’s death, will transfer assets to grandchildren at age 25. At the time the trust was established, it was comprised of a few hundred-thousand dollars. Now, the trust is worth tens of millions of dollars which will be in the hands of grandchildren in their mid-20s in the event the child dies. Thus, given the size of the trust and the fact that the attributes and skills of the grandchildren are now known, it may be desirable for the Trustee to decant the trust so that the grandchildren do not receive the assets until a later age that is more appropriate for the magnitude of assets now held in the trust.
Application of the Act
The Act generally applies to all irrevocable trusts that have their principal place of administration in Nebraska or generally elect Nebraska as the trust’s governing law; but excluding trusts held solely for charitable purposes. Although the trust instrument may generally restrict or prohibit the exercise of a decanting power, such a prohibition or restriction must be very explicit. The Act provides that a general prohibition on the amendment or revocation of a trust, a spendthrift clause, or a general clause restraining voluntary or involuntary transfers of a beneficiary’s interest does not preclude the exercise of a decanting power.
When examining the extent to which a Trustee may exercise the decanting power, a determination must be made as to whether the trust instrument grants the Trustee what the Act calls “expanded distributive discretion” or “limited distribution discretion.” Expanded distribution discretion means the ability to distribute trust income or principal that is not limited by an ascertainable standard or a reasonably definite standard. Thus, where a Trustee has the ability to make distributions in the “best interest” of the beneficiaries or such other broader standard, then the Trustee has expanded distribution discretion. On the other hand, limited distribution discretion exists where the Trustee may only make distributions for “health, education, support, and maintenance” and in cases in which the Trustee’s discretion is essentially fixed and determinable.
Expanded Distribution Discretion
In general, where a Trustee has expanded distribution discretion, the Trustee’s ability to decant is effectively unlimited, except that the Trustee may not add a current beneficiary to the second trust who is not a current beneficiary of the first trust and may not add certain remainder or successor beneficiaries to the second trust unless such beneficiaries are beneficiaries of the first trust. Moreover, the second trust may not reduce or eliminate a vested interest, which is generally a noncontingent right to a distribution or a right to receive an ascertainable part of the trust property the receipt of which is certain to occur and cannot be modified by the exercise of discretion.
Decanting can also be used to add, change, or modify powers of appointment, which are amendment powers held by beneficiaries or other persons. With respect to powers of appointment that exist in the first trust, the second trust must not omit or affect a presently exercisable general power of appointment (this is a power to appoint property to the powerholder and/or the powerholder’s creditors). Otherwise, the second trust may generally retain, omit, create or modify a power of appointment.
Thus, taken as a whole, the decanting power can generally be exercised to eliminate current beneficiaries, make a current beneficiary the remainder or successive beneficiary, eliminate one or more presumptive and successor beneficiaries, alter non-vested rights, extend the duration of a trust, change the trust’s jurisdiction or governing law, modify distribution standards, change the trustee and provisions concerning successor trustees, change the administrative provisions, add investment advisors, trust protectors, or other fiduciaries, and divide and consolidate trusts.
Limited Distribution Discretion
Where the Trustee has limited distributive discretion, the second trust, in the aggregate, must grant each beneficiary of the first trust beneficial interests which are substantially similar to the beneficial interests of the beneficiaries in the first trust. For this purpose, a power to make a distribution in the second trust “for the benefit of the beneficiary” is deemed to be substantially similar to a power to make a distribution directly to the beneficiary. In other words, this type of change would allow the Trustee to make distributions to benefit the beneficiary without actually distributing property directly to a beneficiary. This can be a powerful change for a beneficiary who has shown that the beneficiary is incapable of handling direct distributions. Moreover, if the trust authorizes distributions for “education”, the decanting power could be utilized to better define the meaning of “education” (college, vocational training, etc.).
In addition to the above, it should be noted that even where a Trustee has limited distribution discretion, if a beneficiary has a disability and may qualify for governmental benefits, the Act allows the Trustee to exercise the decanting power in a manner which can create a qualifying special needs trust that will not diminish the beneficiary’s ability to apply for and receive government benefits.
The Act contains additional limitations on the Trustee’s ability to use decanting to reduce or eliminate a determinable charitable interest (including a requirement to notify the Attorney General), to change the Trustee’s compensation, to limit the Trustee’s liability beyond what is provided in the first trust, and modifying provisions concerning the removal and replacement of the Trustee. The Act also contains protections of certain tax benefits such as the marital deduction, annual exclusion gifts, S corporation qualification, and other matters.
In order to effectuate the decanting, the Act generally provides that the Trustee may exercise the decanting power without the consent of any person and without court approval. However, unless waived in writing, the Trustee must provide notice of the intended exercise of the decanting power not later than 60 days before the exercise to each settlor, each “qualified beneficiary”, each holder of a presently exercisable power of appointment, each person that has the right to remove and replace the Trustee, any other fiduciary of the first trust and the second trust, and each person acting as an advisor or trust protector of the first trust, among others. The notice must specify the manner of the decanting by providing a copy of the first trust and the second trust and specify the effective date of the decanting. In order to ensure an effective decanting, the Trustee must act with reasonable care in providing the notice and in locating all persons that are entitled to the notice.
The Act also provides a court application process which allows a Trustee as well as the interested parties to ask the court to provide instructions regarding the authority of the Trustee to decant, the appointment of a special fiduciary to determine whether the decanting power should be exercised, and to approve the decanting power.
When carrying out the decanting power, the Trustee must sign (which may be done electronically) a written document which references the provision of notice to the interested parties as well as the identity of the first trust and the second trust along with the property held by each.
Although the Act explicitly requires the Trustee to act in accordance with its fiduciary duties and in accordance with the purposes of the trust, the Act provides some protection for Trustees. For example, the Act provides that a Trustee that reasonably relies on the validity of the exercise of the decanting authority is not liable to any person for any act or failure to act as a result of that reliance. The Act indicates that Trustees are not under a duty to exercise decanting or even to inform beneficiaries about the applicability of the Act. The Act also contains a broad savings clause that provides that any noncompliant term in the second trust is void to the extent necessary to comply with the Act and any provision that is required to be included in the second trust is automatically inserted. Upon discovery of any noncompliant or omitted term, the Trustee is required to take corrective action. The Act also provides protections for any after-discovered property that was either intended to be retained by the first trust or intended to be transferred to the second trust, by providing that such property is deemed owned by the intended trust.
Ultimately, the Act is a step forward in modernizing Nebraska’s trust law and providing Trustees and other fiduciaries with another tool to address changes in circumstances and further the purposes of irrevocable trusts that are established. If you have any questions about the Act or decanting in general, please contact any member of McGrath North’s Tax and Estate Planning Group.