Modifying a Trust

People often use trusts in their estate plan.  But what if a trust is established and circumstances change.  Can a trust be modified to conform to these new circumstances once the trust is established?

The reasons why people use trusts are manifold. A client might have a minor child and desire a trusted adult family member to manage the inheritance of the minor child if the client dies before the child reaches a certain age.

For instance, a client might put a trust in her last will and testament (called a “testamentary trust”), appointing her sister as trustee of her minor child’s inheritance until the child attains the age of twenty-five. The terms of the trust might instruct the sister to make distributions of trust assets to the child for the child’s health, maintenance, support, and education.  The sister-trustee would make such distributions to or for the benefit of the minor child until the child attains the age of twenty-five.  Once aged twenty-five, the trustee would distribute any funds that remain in the trust to the child, and the child would be free to do with the remaining assets what he wanted once the money was distributed to him.

A person might establish a trust because a child is disabled or because a child has drug or alcohol problems. A person might establish a trust because a child simply has difficulty properly managing money and is a spendthrift.

A person might even establish a trust for her own benefit, thinking that having a trust will in some way assist in the management of her own estate during her life, even if she serves as the trustee of her own trust. Some people are simply sold on the idea that the general concept of a trust is a good idea.

A “trust” is an agreement under which one person, the “trustee,” manages the assets of the trust for the benefit of another person, called the “beneficiary.” The trustee manages the assets as a fiduciary of the beneficiary, meaning that the trustee manages the assets with the utmost duty of care to the beneficiary.  The person who establishes the trust and puts his assets in the trust is called the “grantor.”

A “revocable trust” is a trust that can be modified or terminated by the grantor without the consent of the trustee of the trust. An “irrevocable trust” is a trust that cannot be modified or terminated by the grantor.

With some trusts, the grantor, trustee, and initial beneficiary are all the same person. For instance, Mr. Smith establishes and funds a trust for his benefit naming himself as trustee.  In order to be a valid trust, someone other than Mr. Smith must also be a beneficiary of the trust, so Mr. Smith could name his children as contingent beneficiaries of the trust after his death.

With testamentary trusts, or a trust in a Will, the grantor is the person who creates the Will, the decedent at the time the Will is acted upon. The decedent would have named some to be the trustee and would have named beneficiaries.  The beneficiaries might include the person who serves as trustee, but typically the trustee is not the beneficiary of a testamentary trust.

Once a trust has been established, can the trust be modified or terminated? Mr. and Mrs. Smith put their assets in a trust and name themselves and their children as the beneficiaries of the trust.  Life goes one and situations change.  The terms of the trust, which seemed so well thought-out when they were drafted, now hamper the proper administration of the trust given the current set of circumstances that confront the beneficiaries.  Can the trust be modified to conform to these new set of circumstances?

The answer is, yes. Under certain circumstances, a trust, even an irrevocable trust, can be modified to conform to current circumstances.  The overarching principle with such a modification is that the trust can be modified to conform to the intent of the grantor in establishing the trust in the first instance.  In other words, a court can modify the trust to fulfill the intention of the grantor in establishing the trust.



Should I Name a Beneficiary

            Many people are told that they should designate a beneficiary on their account. Their account might be a 401(k) account, an individual retirement account, an annuity, a life insurance policy, or simply an ordinary bank account.  In most instances, the person is told to name a beneficiary, because by doing so, he will avoid probate, based on the universally-accepted premise that probate is expensive and difficult.  Some people are even told that if they don’t name a beneficiary something dramatic will occur, such as the money in the account will pass to the State.

As with many things, the truth about beneficiary designations is somewhat different than what people believe.  In my opinion, it is very important to name a beneficiary on an IRA, 401k, deferred annuity, or any other tax-deferred account.  Most of these investment types permit favorable income tax treatment if the account names a beneficiary.

For instance, with an IRA, if you name your spouse as the primary beneficiary, then your spouse could roll your IRA over into a new IRA in her name in the event of your death.  If you didn’t have a spouse and you named your child as the beneficiary, your child could take the money out of the IRA over her life expectancy.  In taking the money out over her life expectancy—as opposed to taking the money out immediately, the child can defer the income taxation of the money in the IRA over many years.

Let’s assume that Mr. Smith, aged 80, dies owning an IRA worth $500,000.  Mr. Smith named his daughter, Lisa, aged 40, as the primary beneficiary of his IRA.  Based on life expectancy tables that the Internal Revenue Service publishes, Lisa’s life expectancy is approximately 43 years at the time of Mr. Smith’s death.

Given her life expectancy, Lisa could decide to take the $500,000 out of the IRA over her forty-three year life expectancy if she so choose.  The money in the IRA could continue to grow tax-deferred until such time as Lisa is mandated to remove the money from the IRA.  Only a forty-third of the IRA’s $500,000 value would have to be distributed to Lisa in the first year, or about $12,000.  This is called the Minimum Required Distribution amount.

If Mr. Smith had failed to name a beneficiary on his IRA, then the $500,000 would have to come out of his IRA much more quickly than over 43 years, possibly as quickly as within five years of his death.  Being forced to remove $100,000 a year from the IRA would cause more tax than taking out $12,000 a year.  For this reason, I always advise clients to name a beneficiary on their IRA and other tax deferred accounts, such as 401(k)s.

On the other hand, I am not a fan of naming beneficiaries on all accounts simply to avoid probate.  For one thing, as I have stated many times in the past, the process of probating a Will in New Jersey is extremely simple and extremely inexpensive.

For another thing, naming a beneficiary can have negative, unintended consequences.  By naming beneficiaries on all your accounts, you starve your executor of funds with which to pay your debts.  For instance, if you owe a hospital bill and you named beneficiaries on all of your accounts, how is the hospital bill going to get paid?  The hospital bill still must be paid, but the people who were named as beneficiaries might believe that they can simply refuse to contribute any money to the debt.  This could put your executor in a tough position.  The executor, quite literally, might have to bring a court action against the named beneficiaries to get the money.

What happens if your named beneficiary died before you?  Who gets his share of the account?  Don’t know.  Neither do I.  For all I know, every bank might have different terms on their beneficiary designation contract.  Perhaps Bank 1 says the money goes to the beneficiaries children, whereas Bank 2 says the money goes to the other named beneficiaries on the account.

In my opinion, unless there is a real benefit to naming a beneficiary, then as a general rule, you shouldn’t name a beneficiary.  As with any general rule, there may be exceptions, but the general rule is probably different than what most people think the rule should be.