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George F. Bearup, J.D. Senior Legal Trust Advisor

9-Aug-19

The Hidden Costs of a Trust Decanting

Take-Away: Much has recently been written about the ability to decant a trust’s asset to adapt to changing circumstances. While Michigan permits a trust’s assets to be decanted, either for administrative purposes, or I limited situations to change a trust’s dispositive provisions, it is important to keep in mind that along with the cost to prepare the second trust to which the assets are decanted come other expenses.

Background: In Michigan, if an irrevocable trust includes discretionary trust distribution provisions, the trustee may, unless the trust instrument expressly prohibits the act, distribute all or part of the property subject to the provisions of the trust to a second trust, but only if several conditions are met.

Unlike the Uniform Trust Decanting Act (UTDA), Michigan’s decanting statutes [we have two, one which is part of the Michigan Trust Code, and the second which is under the Powers of Appointment Act] require the creation of a second trust to be created to which the trustee distributes the assets from the first trust.

  • Administrative Decanting: The changes to the administrative provisions of an irrevocable trust are governed by MCL 700.7820a(1), which provides in part: If an irrevocable trust includes a discretionary trust provision, the trustee of the trust may, unless the terms of the first trust expressly provide otherwise, distribute by written instrument all or part of the property subject to that provision to the trustee of a second trust, provide that both of the following conditions are satisfied: (a)- the terms do not materially change the beneficial interests, and (b)- the terms of the second trust are not inconsistent with the tax planning that informed the first trust…
  • Dispositive Decanting: The changes to the dispositive provisions of an irrevocable trust are governed by MCL 556.115a(1), which provides in part: A trustee with a presently exercisable discretionary power to make distributions of income or principal of an irrevocable trust to or for the benefit of one or more beneficiaries of the trust may, unless the terms of the first trust expressly provide otherwise, exercise the power by appointing all or part of the property subject to the power in favor of the trustee of a second trust, provide that all of the following conditions are satisfied: (a)- the beneficiaries of the second trust include only permissible appointees of the trustee’s discretionary power as of the time the power is exercised; (b)- if it is an IRC 2503(c) ‘minor’s trust’, the beneficiary’s remainder interest will be paid as if it had passed or been payable under the terms of the first trust; (c)- the power’s exercise will not reduce the income, annuity or unitrust interest or the general power of appointment of a trust beneficiary that is intended to qualify for the marital or charitable deduction; and (d)- the power does not reduce a presently exercisable general power to withdraw a specified percentage or amount of trust property in a trust beneficiary who is the only trust beneficiary to or for the benefit of whom the trustee has the power to make discretionary distributions.
  • Notice: The dispositive decanting statute provides that the second trust shall be treated as a new irrevocable trust for purposes of the notice requirements of MCL 700.7814(2). The Michigan Trust Code requires written notice to the settlor (if living) and to all qualified trust beneficiaries no later than 63 days before the trustee exercises the trust decanting power, to give to them the opportunity to object to the proposed decanting. [MCL 700.7820a(7).]
  • [Note: Delaware’s decanting statute does not require any notice to trust beneficiaries before the trustee can exercise its decanting power.]

Hidden Costs: Consequently, both Michigan statutes contemplate the creation of a second trust to which assets from the first trust are transferred. The cost associated with the creation of the second trust  instrument and the costs incurred with the actual transfer of trust assets to the second trust, along with the customary costs associated with the effective termination of the first trust, e.g. a final fiduciary accounting provided to all trust beneficiaries, a final income tax return, may all prompt a trust beneficiary to object to the trustee’s proposed trust decanting.  The dispositive decanting statute indicates that the second trust shall be a continuation of the first trust for notice purposes, but it is not clear if the first trust will have to be formally terminated with the additional expenses incurred with its termination.

UTDA: The Uniform Trust Decanting Act, and a few state decanting statutes e.g. California, also permit a distribution from the first trust to the second trust. However, unlike Michigan’s decanting statutes, the UTDA and these other state statutes also allow the trustee to identify the specific provisions of the first trust that are to be modified, much like an amendment to that first trust. In other words, the trustee can either create the second trust, or the trustee possesses the option to treat as a second trust a continuation of the first trust after its modification.

Continuing Trust Concept: If the second trust is treated as a continuation of the first trust by the trustee, there may be no need to formally terminate the first trust for income tax purposes, nor the need to obtain a new tax identification number for the continued trust, or the need to retitle assets in the name of a ‘new’ trust. Also, it is less likely an asset might be overlooked in its transfer from one trust to the second trust. In sum, the use of a continuing trust concept under the UTDA can reduce the burden and expense of the trustee’s exercise of a trust decanting power initiated by the trustee.

Limitations in Decanting Powers: As was reported a few months back, a Nevada court refused to permit half of a trust’s assets to be decanted to a second trust. The original trust required the unanimous consent of two trustees to make a distribution from a charitable trust. Only one of the two co-trustees wanted to decant one-half of the trust into a new trust, where the second trust would continue the purpose of the settlor, but with just one trustee acting as sole trustee. The original trust would retain the other half of the trust assets with the other co-trustee acting as sole trustee. The Nevada court refused the proposed decanting, since the original trust instrument required both trustees to agree before a distribution could be made from the trust. In the Matter of the Fund for the Encouragement of Self Reliance, An Irrevocable Trust, 135 Nev. Adv. Op. (March 21, 2019.)

Conclusion: While a trustee now possesses the power to decant trust assets under Michigan statutes, there always lingers the concern that the trustee’s unilateral decision to decant trust assets to a second trust might inadvertently cause the trustee to breach its duty of loyalty to all trust beneficiaries. [MCL 700.7802(1).] For example, merely decanting the first trust’s assets to the second trust which contains provisions now authorized by the Michigan Divided Trust Act, where the trustee’s duties will be bifurcated among other trust directors, could arguably invoke fiduciary loyalty concerns due to the resulting shift in liability away from the decanting trustee through the use of multiple trust directors. In sum, just because the trustee now possesses the authority to decant trust assets, thought also needs to be given to the additional costs associated with creating the second trust along with the concomitant costs associated with formally terminating the first trust, not to mention lingering concerns with regard to the trustee’s fiduciary duty of loyalty to all trust beneficiaries.