The original article was published on June 11, 2024 and has been revised by the author. Since the original post, the Pennsylvania Uniform Trust Directed Trust Act has been passed.
In the realm of estate planning, irrevocable trusts have long been tools for asset protection, tax efficiency and wealth preservation. However, as the dynamics of family structures, financial landscapes and legal frameworks evolve, the need for flexibility within these trusts has become increasingly apparent. This need is most often addressed through modification of such trusts through the powers given to others to do so.
From changing beneficiaries to adapting trust terms, the journey of trust modification is rife with complexities that demand careful navigation. In this article, we discuss the intricate process of amending and modifying irrevocable trusts, including, but not limited to, the use of a Trust Protector.*
What Is a Trust Protector?
Trust protector is a position that came into prominence when asset managers started to entice residents of the U.S. to move their money into offshore business investments as a means of asset protection. This would necessarily involve the appointment of a trustee beyond the reach of U.S. courts. Trusting your fortune to a foreign trustee was not an appealing prospect for many; hence, the position of trust protector became more commonly used to ensure onshore governance of a foreign asset trust.
The use of trust protectors for trusts is addressed, though not explicitly, by UTC §808, which Pennsylvania later adopted as §7778 of the Pennsylvania Probate, Estates and Fiduciaries Code (PEF Code), stating that a trust instrument may confer on a trustee or other person the power to modify or terminate a trust. The statute also imposes the assumption that, absent language to the contrary, the trust protector owes a fiduciary duty.
A trust protector can be thought of as an extension of the settlor’s intent. Trustees are bound by the trust instrument and cannot act contrary to its terms, even if they believe the settlor would have wanted them to; however, a trust protector can direct the trustee to act in such a way, or even amend the trust to enable the trustee to act in a way contrary to the original trust instrument.
For example, suppose that a grandmother creates an irrevocable trust for her grandchild that is to be used to fund that grandchild’s medical school expenses. However, the grandmother died before the grandchild completed his undergraduate education. Her grandchild realized that he would rather be a dentist and asked the trustee to disburse funds adequate to pay for such an education. Unfortunately for the grandchild, dental school and medical school are distinct from one another and the trustee cannot pay for it. Assuming the appointment of a trust protector for the irrevocable trust, the trust protector can direct the trustee to pay regardless or amend the trust altogether to include dental school, as long as the trust protector was explicitly granted the power to amend the trust or direct the trustee regarding disbursements.
Why Use a Trust Protector?
A trust protector makes the most sense for long-term irrevocable trusts which are designed to hold assets across generations, such as business interests or land, or for dynasty trusts that hold securities. Trusts created with assets likely to be affected in unexpected ways by the changing legal landscape, such as cryptocurrency, may also benefit from a trust protector. A settlor might want a trust protector when they believe the chosen trustee does not have enough subject-matter knowledge regarding the specific trust assets and wishes someone to oversee such assets, but otherwise believes the trustee is competent to manage the trust.
One significant advantage of using a trust protector is that it affords a greater amount of privacy to the settlors, trustees and beneficiaries, eliminating, in most cases, the need for oversight by an Orphans’ Court. This can limit the disclosure of confidential information, such as personal information, asset information and the identities of beneficiaries.
Cons of Using Trust Protectors
The drawbacks of having a trust protector, though, aren’t inconsequential. They include added expense, not only because you need to compensate the trust protector, but you also may need to pay trustees more as it is more work for them in many cases. While a trust protector is, ideally, someone with knowledge of the settlor’s wishes, it is not a requirement. This may be an issue for trusts meant to last for generations, where subsequent officeholders may have little to no idea what the settlor might have wanted.
The power and duties of a trustee have been established by centuries of laws and legal precedent. This is not the case for a trust protector, especially in Pennsylvania, due to the lack of legal precedent or statutory authority governing trust protectors. Because of that, drafting the powers and limitations of a trust protector requires a great deal of forethought and careful planning. A trust protector who exercises too much power and stymies the trustee undermines their authority and diminishes the beneficiaries’ confidence in the trust’s management. A trust protector with too little power is not much more than an expensive figurehead.
Other Options
Even without a trust protector, in some jurisdictions such as Pennsylvania, trustees may terminate a trust without court approval if they conclude that the value of the trust property is insufficient to justify the cost of administration. Such termination does not require a court order; only that the beneficiaries are given at least 60 days to file a written objection. The original UTC provision §414, envisioned that a trust with $50,000 or less would be sufficiently inefficient to administer. Pennsylvania stripped such dollar thresholds when they passed §7740.4(a) of the PEF Code. The Pennsylvania statute is a default rule that applies if the governing document is silent on the matter. A settlor is free to expressly provide in the instrument that the trust can be, or shall be, terminated once the trust assets are diminished to a specific amount designated by the settlor.
The cost of administering a trust can be considered too high if the purpose of the trust is to provide income for a beneficiary and the income of the trust is insufficient to pay out the income and pay for the trust’s administration expenses. However, paying out more for expenses than a trust receives in income does not necessarily justify termination in the case of a trust holding principal to be distributed when the beneficiary reaches a certain age. For instance, irrevocable trusts are often used to hold stock in closely held corporations, especially for closely held family businesses, until a beneficiary has attained a certain age. Many such businesses do not pay out income to shareholders. Such a trust is surely paying out more in administration fees than it is receiving but will nonetheless continue to exist despite running this deficit. There are exceptions, however, should the stocks held in the trust become essentially worthless.
If you prefer to avoid the additional expenses and potential ambiguity of a trust protector, there are other avenues available for modifying or terminating irrevocable trusts, though they may require court approval. Trusts are usually created with specific goals in mind, but circumstances may change over time, necessitating modifications or even termination. Any modifications or terminations must align with the trust’s original objectives and require the unanimous consent of all beneficiaries. Furthermore, if the settlor is able to consent, it is possible to avoid the need for court approval in certain situations. You can modify or terminate a trust without the unanimous consent of all beneficiaries, but the process is much more difficult and beyond the scope of this article.
The ability of a court to modify an irrevocable trust by a petition of the beneficiaries hinges on the preservation of its material purpose. This requirement serves as a safeguard against changes that deviate from the settlor's original intent, while still allowing for changes. Determining what constitutes a material purpose can be a nuanced undertaking, often necessitating an examination of the context behind the trust's creation, the specific language used, and the interests of the beneficiaries created by the trust instrument. Clarity in expressing the settlor's objectives within the trust document can mitigate ambiguity and facilitate the interpretation of material purposes. In the case of trust termination, the court must determine that the continuance of the trust is not necessary to achieve any material purpose.
If the settlor and all beneficiaries agree, the trust may be modified or terminated even if that modification or termination would be inconsistent with the material purpose or objective of the trust. A representative of the settlor, such as a guardian or an agent under a general power of attorney, may represent the settlor in this matter.
A dispositive consideration in trust modification or termination is the presence of a spendthrift provision, which is presumed to embody a material purpose of the trust. Such provisions are designed to protect beneficiaries from their own wastefulness or from the claims of creditors, underscoring their significance in the trust framework.
Unforeseen Circumstances
A settlor, trustee or beneficiary, standing alone, may initiate a judicial proceeding to modify an irrevocable trust’s administrative or dispositive provisions if there is an unforeseen change in circumstances and a frustration of the settlor’s main objective. A circumstance can be in effect at the time of the trust’s drafting and still be considered unforeseen.
In the case of In re Est. of Girard, 132 A.3d 623, 635 (Pa. Commw. Ct. 2016), the Board of Directors of City Trusts filed a petition to modify a testamentary charitable trust created by the Will of Stephen Girard in 1831 (Charitable Trust). The Charitable Trust called for the creation and funding of what was essentially a boarding school (College). The Charitable Trust, coming under financial strain, combined with the College’s need to spend over $110 million on repairs and renovations, led to the College’s Steering Committee proposing, and ultimately adopting, a moratorium on the College’s residential housing of students. The Charitable Trust petitioned the Orphans Court for approval of this modification, and the Orphans’ Court ultimately rejected the petition, as did the Commonwealth Court.
One can easily assume that Girard could not have anticipated the 2007 financial crisis and the decline of coal revenues over a century and a half in the future. However, Girard’s Will stated that the size of the College would be determined by the income able to support it. This, the court reasoned, showed that Girard did anticipate that the Charitable Trust’s value could fluctuate over time.
For any lawyer petitioning the court for a trust modification or termination based on unforeseen circumstances, it is important to meticulously document the unforeseen circumstances that you believe necessitate a modification or termination. Modification petitions should be framed as preserving the trust’s material purpose, keeping in mind the fiduciary duty owed to each beneficiary. The proposed changes should be beneficial to all beneficiaries while balancing the trust’s original purpose. Being allowed to amend the trust, though, is only half the battle. The proposed changes should also be precise and contain enough foresight to avoid any similar issues in the future.
Tax Objectives
A settlor, trustee or beneficiary, standing alone, may also initiate a proceeding to modify a trust to achieve the settlor’s tax objectives. A trust drafted in 1990 will be markedly different than one drafted after 2017 regarding its tax objectives. For instance, the increased generation-skipping transfer (GST) tax exemption allows a trust to leave more assets to “skip persons” without adverse generation-skipping taxes than would have been possible in 1990. Whether such a change will be recognized for federal tax purposes is a matter of federal law. Some specific modifications that the IRS has authorized are the revision of split-interest trusts to qualify for the charitable deduction, the modification of a trust for a noncitizen spouse to become eligible as a qualified domestic trust, and, as in the above example, the splitting of a trust to utilize better the exemption from GST tax. The law permits a court to make a modification retroactive, but the court is not required to do so.
Ultimate Goal: Original Intent
While irrevocable trusts serve as invaluable tools for asset protection, tax efficiency and wealth preservation, the evolving nature of financial landscapes and family dynamics requires flexibility. Modifying or terminating a trust requires careful consideration of legal avenues, practicality and the inevitability of unforeseen complexities.
Ultimately, whether you are appointing a trust protector or petitioning for a court-approved modification, the ultimate goal is, and should be, the settlor’s original intent. Clarity in drafting trust documents, a thorough understanding of the settlor’s objectives and strategic planning are of the utmost importance. By navigating these complexities with diligence, trustees, beneficiaries and legal advisers can ensure that the trust continues to serve its intended purpose.
*This article focuses on noncharitable irrevocable trusts. Where charitable irrevocable trusts are mentioned, it is because the relevant provisions applicable to them are the same or similar to those pertaining to noncharitable irrevocable trusts.
The original article was published on June 11, 2024, and has been revised by the author. Since the original post, the Pennsylvania legislature passed the Uniform Directed Trust Act.