Trusts provide advantages, including protection from creditors, divorce, or spendthrift behavior. To obtain these advantages, trusts place restrictions on a beneficiary's access to and use of trust property.

A trust's terms represent a forecast by the settlor about future tax, financial, and family circumstances. This forecast balances restrictions and flexibility in a way that makes sense at the time, but sometimes a trust agreement's implied predictions turn out to be wrong.

For instance:

Descendants may have turned out to be much richer (or poorer) than predicted.

In-laws may have turned out to be more agreeable than expected.

Beneficiaries may have special needs, or heightened asset protection concerns of their own.

Tax laws may have changed.

In instances like these, "decanting" the old trust into a newer, updated trust can be an effective response to the new circumstances facing a family. Since 2012, a Kentucky statute (KRS 386.175) has made decanting more cost-effective, and thereby available to address a wider range of trust situations. It's worthwhile to take a quick look at how Kentucky's decanting statute works.

If income and/or principal distributions from the old trust are discretionary, the trustee of the old trust may appoint all or part of the principal or income of the old trust over which the trustee has discretion to a new trust.

The decanting statute has both permissive and restrictive aspects. In a decanting, some of the things that can be done include:

The trustee can do the decanting without court authorization.

The new trust can be created or administered under the laws of any US or foreign jurisdiction.

The new trust can give a discretionary beneficiary of the old trust a power of appointment.

The beneficiary given the power of appointment in the new trust can exercise this power in favor of persons who are not beneficiaries of the old trust, or of the new trust.

The beneficiaries of the new trust can include some (but not all) beneficiaries of the old trust.

The discretionary distribution standards in the new trust can be more restrictive than the standards in the old trust.

The decanting statute also provides that several things can't be done, including:

The new trust can't include any beneficiaries that weren't beneficiaries of the old trust.

The new trust can't accelerate a beneficiary's future interest in the old trust to a present interest.

The new trust can't reduce a beneficiary's fixed income, annuity, or unitrust in the old trust.

The new trust can't change provisions in the old trust that relate to a marital gift or estate or charitable gift, estate, or income tax deduction, if the changes would have disqualified or reduced those deductions, if they had been in the old trust.

If the old trust owns S corporation stock, the new trust can't have any provisions that prevent or eliminate a qualified subchapter S ("QSST") or electing small business trust ("ESBT") election.

The discretionary distribution standards in the new trust can't be less restrictive than the standards in the old trust.

With the statute's "cans" and "can'ts" in mind, its easy to see how decanting could be incredibly useful in a range of situations.

Examples of how decanting can help trustees include:

A trustee of a discretionary "sprinkle" trust with multiple beneficiaries in the same generation with very different financial needs can decant the trust into new, separate trusts, each funded equally from the old trust. Each new trust could have as its beneficiaries only one branch of the original settlor's family. The result is that future wealth of other family branches won't be diluted by the near-term needs of another family branch.

When beneficiaries disagree about a trust's investment policy, the trust can be decanted into new, separate trusts that better align the new trusts' investment preferences with each family branch or group of beneficiaries.

When beneficiaries live in different states with different income tax rates, decanting a trust into new, separate trusts makes it easier to optimize a trust's investment mix and distribution policy with a beneficiary's particular income tax circumstances.

Examples of how decanting can help beneficiaries include:

When an old trust has a remainder beneficiary with special needs, decanting the old trust into a new trust with revised provisions can protect the beneficiary's eligibility for various means-tested government programs (such as SSI).

An old trust might not allow its beneficaries to appoint trust assets to persons other than the settlor's descendants. This can create difficulty or perceived unfairness when an adult beneficiary does not have descendants of his or her own, or when trust assets are important to support the lifestyle of an adult beneficiary's spouse who might survive the beneficiary. Decanting the old trust into a new trust with expanded powers of appointment can be an efficient solution.

An adult beneficiary might be concerned about the old trust's outright distribution at a certain age, when that beneficiary's child is not yet responsible, or might have substance abuse issues. Decanting the old trust into a new trust with more restrictive distribution standards addresses the concerns.

An adult remainder beneficiary might want to avoid an outright distribution to themselves, whether to prevent an increase in their taxable estate, or to enhance long-term creditor protection. Decanting the old trust into a new trust that will last for the beneficiary's lifetime, rather than distributing outright offers a solution.

Because decanting can offer such a high degree of flexibility, it's important for clients creating new trust agreements to consider whether they want their new trusts to embrace the statute, or avoid it (to the extent they can). Trusts written to maximize flexibility offered by decanting will necessarily include provisions very different from those of trusts designed to avoid changes from future decanting. We'll discuss those drafting considerations in a future post.