Decanting: Not Just for That Bottle of Cabernet

Trust “decanting” refers to the technique of transferring assets from an existing irrevocable trust to a new irrevocable trust, typically with more favorable terms. The power to transfer assets from one trust to another is commonly derived from the trustee’s broad discretionary authority to make distributions to, or for the benefit of, the beneficiaries of the original trust.

Decanting has the effect of amending what was typically intended to be an unamendable irrevocable trust, by allowing the trustee to distribute trust property to a second trust with terms that may differ substantially from those of the original instrument. The concept of trust decanting is based on the theory that if a trustee is granted broad authority to distribute trust property for the benefit of the trust’s beneficiaries, the trustee likewise has the authority to distribute property to another trust for the benefit of those same beneficiaries. (For more, see: Irrevocable Trusts: New Trends You Need to Know.)

The Power of Decanting

A common reason for decanting a trust is to extend the life of the trust by removing mandatory distributions to beneficiaries at stated ages - a practice that can yield greater creditor protection for the beneficiaries. For example, if the old trust agreement mandated a principal payment of 30% to a trust beneficiary at a time  when the beneficiary was in the midst of a divorce, those funds could potentially become subject to the claims of the divorcing spouse. Removing that mandatory payout provision through decanting may mitigate these risks.

A similar scenario played out in a recent decision: Michael J. Ferri, et. al. v. Nancy Powell‐Ferri et. al. The case not only illustrates the power of decanting, but also serves as a reminder about the importance of building flexibility into the terms of a trust.

In Ferri, a father created an irrevocable trust for his son’s benefit in 1983 when the son was 18 years old. The trustees of the 1983 trust had broad discretion to make payments of principal and income to the son as needed. Additionally, the son had the right to request a withdrawal of trust principal in certain percentages, beginning with 25% at age 35 and increasing to 100% by age 47. The son used some of his withdrawal powers throughout his life, but the majority of the trust’s principal remained within the trust. In 1995 when he was 30 years old, the son married. At age 45, after 15 years of marriage, the son filed for divorce. A year after the son filed for divorce, the trustees decanted the principal of the 1983 trust to a new 2011 trust. The 2011 trust was a spendthrift trust where the son had no authority to demand payment of trust principal - any distributions from the 2011 trust were left to the sole discretion of the independent trustees. The decanting occurred without the son’s knowledge or consent. (For more, see: How to Set up a Trust Fund If You're Not Rich.)

The trustees’ actions effectively removed the trust from the marital estate, meaning it was not subject to equitable distribution following the dissolution of the marriage, even though the divorce proceeding had commenced prior to the decanting. Overall, this illustrates how decanting can be a very powerful tool to remove assets from the reach of a divorcing spouse. The court did mention that the balance of the trust assets should be considered when determining maintenance payments, but the assets were ultimately protected from distribution.

The many misfortunes that can derail a beneficiary’s future are not always foreseeable at the time of trust creation: substance abuse, negligence, divorce, improvidence, failed business ventures, etc. A lifetime spendthrift trust, in which assets are never required to be distributed directly to the beneficiary, can mitigate the financial strain these types of events can have on an individual. The facts of Ferri warn against mandatory income or principal distributions from trusts - perhaps such mandatory payouts should never be included in the first place, but decanting offers a “way out.”

State Statutes

Many states, such as New York, Florida and Delaware, have created statutes governing the decanting of trusts. Other states, like Connecticut, New Jersey and Massachusetts, rely on the development of common law surrounding trust administration. Typically, the authority for the trustee to decant a trust is not expressly stated in the governing trust document. Rather, decanting ability is based on the interpretation of language contained in the trust and the settlor’s intent. The more discretion over the distribution of trust assets a trustee has, the more likely it is that the trustee will have the ability to decant a trust.

Some settlors are uncomfortable with giving a trustee sole discretion over the distribution of trust assets because they want to ensure that the trust’s beneficiaries will be taken care of, and have access to trust funds should a need arise. One way to address this concern is to give trust beneficiaries the power to hire and fire trustees or to become a co‐trustee, with limited powers, at a specified age. In other words, the settlor can simultaneously give the independent trustee full discretion over trust distributions, but also give the beneficiary a level of control over who serves as trustee. The powers that a settlor gives to the beneficiaries are customizable to a large degree.

It is always important to take a long‐term view when creating irrevocable trusts and to consider not only the positive events that will occur in a beneficiary’s life but some of the pitfalls as well. While decanting is a useful tool to undo some of the missteps of the past, it is far better to avoid such terms to begin with. (For related reading, see: 7 Reasons to Own Life Insurance in an Irrevocable Trust.)