How do you know if your estate plan needs fixing? Perhaps changes have occurred in your family, personal wealth, or maybe you are recently married or divorced. Unintended consequences may exist in your planning documents that require a revisit. Tax laws change or you may discover that a change to your plan is necessary, but in any event, it still begs the question, how do you fix your broken estate plan?
There are four primary reasons why an estate plan needs work: (1) Incomplete Formation; (2) Changed Circumstances; (3) Changes in Tax Laws; and (4) Families Change Over Time.
1. Incomplete Formation
The estate plan may be defective from creation because the planner lacked an understanding of or was unsuccessful in obtaining the client’s actual financial positioning, objectives, or family circumstances. Here, the plan was drafted without the complete picture. The plan may also fail to consider crucial information regarding assets, family agreements, children from prior marriages or from out of wedlock, or even anticipated inheritances.
2. Changed Circumstances
This situation occurs when a once adequate estate plan no longer achieves the objectives of the grantor or beneficiaries in the way the client intended. For example, children become financially independent and prefer the inheritance to directly benefit the client’s grandchildren. Children or beneficiaries may develop drug or alcohol problems, divorce their spouse, have poor credit, become engulfed in debt, or later become subject to a restitution order stemming from criminal charges. These circumstances can cause the client to desire or a need to change beneficiary designations. Alternatively, beneficiaries may be born with or develop special needs or suffer major injuries resulting in disability, he or she may receive government assistance such as SSI or Medicaid. An outright distribution or inheritance could cause the beneficiary to lose his or her government benefits. This may require the implementation of a Special Needs Trust (“SNT”). Changes in personal wealth or the successor or failure of a family business may occur after the estate plan is crafted. Lastly, the economy may undergo a recession, depression, or skyrocket gaining substantial value.
These are just some examples of circumstances where an estate plan must be reexamined and potentially reworked.
3. Change in Tax Laws
A change in tax laws may also cause the need for an estate plan to be reformed. Income taxes, estate, gift, and generation- skipping transfer (also known as “GST”) taxes are some of the taxes that can change or alter the effectiveness of an estate plan. The effect of income taxes on an estate plan is becoming increasingly important as the federal estate tax exemption continues to increase, currently at $5,430,000 for the year 2015. How do you know the tax consequences of your plan? You can request a Private Letter Ruling (known as a “PLR”) from the IRS, which is a written statement issued to the taxpayer by IRS, interpreting and applying the tax laws to a specific set of facts prior to the occurrence of such event.
4. Families Change Over Time
Families grow and become smaller over time. The once tight-knit family may become fragmented or move far from one another causing the family to grow apart. Married couples divorce and remarry, blended families are the end result. A once well settled estate plan can produce unintended results or exclude children or beneficiaries who would unquestionably be included in the plan.
Methods to Fix Your Estate Plan
Many estate plans can be fixed when the documents are revocable such as a will or revocable trust, provided the testator or settlor (client who created the document) is still alive, able, and possesses the legal capacity to execute the legal documents. Most problems occur when the document is irrevocable or the client has since passed.
State law governs wills and trusts. State law, therefore, dictates how and when the terms of these instruments can be changed or modified. Many states follow the Uniform Trust Code (commonly referred to as the “UTC”) drafted in 2000 by the National Conference of Commissioners on Uniform State Laws. Twenty nine states and the District of Columbia have adopted the UTC, with slight modifications by each state. Florida, Massachusetts, and Pennsylvania are all examples. Other states, such as New Jersey and New York, have adopted their own set of laws to govern trusts. New York follows the New York Uniform Trust Code. New Jersey trust law has been well settled for over 150 years and is governed
by New Jersey Statute Title 3B, the Uniform Probate Code.
There are several methods for repairing estate planning documents. Three primary and common methods are through: (1) Reformation; (2) Amendment; and (3) Decanting. There might be more than one suitable remedy for each situation, but determining the available remedies depends on the facts and circumstances surrounding each trust change.
Determining the correct approach to reforming a broken estate plan involves a three step process: examining the trust document or will; analyzing the available remedies under applicable law; and discerning the likely tax consequences of keeping the plan as-is or reform the plan.
A court may reform the terms of the trust, even if unambiguous, to conform to the settlor’s intentions if it is proved by clear and convincing evidence what the settlor’s intention was and that the terms of the trust were affected by a mistake of law or fact, whether in expression or by inducement. Reformation can be a helpful method to change the trust terms and is available to both charitable and non-charitable trusts. It is based on the premise that an error was made during the creation of the trust, and the correction can be effective relating back to its creation.
Unlike reformation, an amendment or trust modification is effective as of the date of the amendment and does not relate back to the trust creation. Trust reformation can be difficult because it requires establishing the now deceased client’s intent and whether the Internal Revenue Service will accept such changes. Modification by consent is a means of amending a trust upon obtaining the written consent of all parties including the beneficiaries, trustees and settlor, as the case may be. Another method of modification is because of unanticipated circumstances. The court may modify the terms of a trust or terminate the trust, if because of circumstances not anticipated by the client, modification or termination will further the purpose of the trust. Trust may be modified by the Cy près, a term of French origin meaning as near as possible. Here, an application is made to the court when the original objective of the settlor or the testator later became impossible, impracticable, or illegal to perform. The Cy près doctrine allows the court to amend the terms of the charitable trust as closely as possible to the original intention of the testator or settlor to prevent the trust from failing.
Note that not every modification method will work for a given trust. For example, some trusts cannot be modified by consent, even if all beneficiaries and trustees agree. An application to the court may be required.
Often, trusts previously prepared may contain unintended or undesirable provisions that are irrevocable and therefore cannot be changed. Decanting, much like one would do with wine, is the process by which the assets of the trust affected by the undesirable results, are poured into a newly created trust or trusts with provisions that meet the new or intended objectives. The tax implications of decanting require careful attention to all types of taxes including income, gift, and estate tax consequences.
4. Other Remedies
Other common measures include defensive estate planning whereby the best plan of action is to continue with the current plan and limit the liability and exposure of the executor or trustee. A disclaimer or renunciation is also a useful mechanism whereby the beneficiary who has not yet accepted the bequest or distribution renounces the trust or gift so that it passes to another beneficiary in accordance with the terms of the document or applicable law.
We are experienced in these matters and can help. If you think your estate plan may need to be revisited, please feel free to contact our firm’s Tax, Trust & Estate Department.