In this article, we explain trust reformation in Illinois. Even the best plans can face unexpected hurdles. If a will or trust does not address unforeseen circumstances, one can expect litigation by competing beneficiaries. So, what happens when a trustee or beneficiary needs to alter the language of a trust that belongs to a deceased settlor? The answer is a legal proceeding, known as “trust reformation.”
In this article, we’ll answer the following questions:
· What is a trust?
· What is a trust reformation?
· Why would you reform a trust?
· How to reform a trust?
A trust is a fiduciary arrangement that allows a third party, or trustee, to hold assets on behalf of a beneficiary or beneficiaries. Trusts can be arranged in many ways to specify exactly how and when the assets need to pass to the beneficiaries. Because trusts usually avoid probate, your beneficiaries may gain access to those assets more quickly than they might to assets that are transferred using a will. Assets in a trust may also be able to pass outside of probate, saving time, court fees, and potentially reducing estate taxes, too. For more information about different kinds of trusts, please see the article What is a Trust? Illinois Trusts Explained.
A trust reformation is the modification of an irrevocable trust to address unanticipated changes that have occurred since its establishment or to clarify the language of the trust instrument for the benefit of trustees and beneficiaries.
While it is possible to reform a trust for various reasons, trustees and beneficiaries do not have the power to change an irrevocable trust simply because they want to. There are several reasons why one would consider a trust reformation. For example, maybe two of the beneficiaries are a settlor’s daughter and her husband, but now several years later, the two get a divorce. Perhaps one of the trustees died, and the trust didn’t provide a way to choose a successor trustee. Trust reformations are great for protecting or enhancing trust assets, providing more flexibility on investment of assets, changing the distribution scheme set out in the trust instrument or avoiding potential litigation because the terms of the trust are too vague.
In order to modify an irrevocable trust, one would typically initiate a court procedure to request approval of the change or modification. There are three kinds of trust reformation:
1.) Modification by Consent:Trust modification is easiest when all parties can agree on one solution, so the modification or termination of a non-charitable irrevocable trust may be executed with a single “consent modification” document if the trust’s grantor and all possible beneficiaries agree; every beneficiary who may receive trust property now or any time in the future, no matter how minute the possibility, must consent to the proposed action. If any of the beneficiaries are minors, consent may be given on the beneficiary’s behalf by a parent or guardian. If a single potential beneficiary refuses, the modification procedure is not viable.
2.) Modification with Court Approval:When the grantor will not or cannot consent to action proposed by all of the potential beneficiaries, the court may allow trust modification or termination anyway. Again, all of the potential beneficiaries, no matter how minute the change, have to agree to petition to approve their proposed action. Unlike consent modification, however, the court-approved modification may not frustrate a “material purpose” of the trust. In some situations, the court may approve a proposed modification or termination of the trust’s material purpose if the reason for such modification or termination “substantially outweighs” accomplishment of the material purpose. If the contsent of all beneficiaries cannot be obtained, the court can still modify an irrevocable trust if the interests of the non-consenting beneficiaries will be adequately protected.
3.) Decanting to Modify Irrevocable Trusts: Modification or termination of a trust affected by consent or approved by the court turn primarily on the desires and actions of a trust’s beneficiaries. Trustees of certain trusts are allowed to modify the way a trust is administered by distributing, or “decanting” trust assets from the original trust to a second trust with more favorable terms. This statutory power allows a single party, the trustee, to modify a trust without court involvement or beneficiary consent. Decanting is usually only available if the beneficiaries' rights will be the same in both the old trust and the new trust. It is generally used to work around out-of-date provisions and not to change the rights of the beneficiaries.
Any of these strategies would allow you, whether you’re a trustee or a beneficiary, more flexibility with an existing trust. Remember, modification or termination of a trust may result in gift, estate, generation-skipping tax, and even income tax consequences. If you have any questions or concerns regarding will and trust reformations, please do not hesitate to contact us today.