The Most Overlooked Provision in Your Trust Documents

When creating an estate plan, tension often arises between carrying out the wishes of the person setting up the trust (aka the settlor) and the requirements of the law. The law often requires the settlor to make certain commitments in order to get tax and related benefits. That is why irrevocable trusts often make people nervous. The word “irrevocable” has finality to it, and raises the question, “Am I really sure that this is what I want, and will the estate plan still work for my family in a decade or more from now?” Likewise, trusts that aren’t per se irrevocable, such as a living trust, can become irrevocable at some point following the death of one or both of the settlors (e.g., marital and bypass trusts, as well as various trusts for children). Thus, even the most common trusts can benefit from introducing an element of flexibility into the manner in which they are ultimately administered.

There is an underutilized way to introduce flexibility into trusts that by their terms are irrevocable or will become irrevocable. Surprisingly, the key language often appears as boilerplate in many trust documents.

What is this important and overlooked language?

It’s the choice-of-law provision. Yes, the standard language that specifies which law will govern the interpretation and enforceability of the trust is much more significant than many financial advisors, accountants, and other professionals realize. This is especially true where the trust document provides that California law applies. Under California law, an irrevocable trust can be difficult to modify. But that is not the case in every state. Different jurisdictions permit different levels of flexibility for irrevocable trusts. In more than 20 states, an irrevocable trust can be decanted. Just as the wine in the bottle can be transferred into a decanter, states that allow an irrevocable trust to be decanted allow the trust to decant out of the old trust into a new trust with different provisions. This is an elegant way to in effect modify an irrevocable trust.

California, by contrast, has not enacted a statute that permits decanting of irrevocable trusts. Thus, in California, irrevocable trusts can be generally modified only by the consent of all interested parties or by court order. For example, if the settlor passes away, he or she can’t provide consent. Likewise, the settlor may lack capacity to change the trust, or disgruntled beneficiaries may refuse to consent to the change. These are just a few of the many ways a trust governed by California law can’t or won’t be changed by consent. In such cases, if a trust governed by California law is going to be modified at all, it will require the intervention of the Probate Court.

A properly drafted choice of law provision will, if necessary, allow the applicable law to be changed at some point in the future. It’s more complicated, however, than deleting California from the relevant provision and replacing it with Nevada or some other state. The trust documents need to include other enabling provisions.

For most of my clients California law is the initial and natural choice of law. However, there are provisions in their trust documents that allow that choice of law to be changed. This can be an especially effective way to provide for the flexibility that helps protect families from changed and hard-to-predict circumstances.

If your current estate plan documents only include California for choice of law purposes, or if you are considering creating an irrevocable trust, make sure that the “boilerplate” provisions in your trust documents are not actually boilerplate.

As always, I look forward to your questions or comments.

Kevin Moore, Founder of Kevin J. Moore & Associates, is focused in the areas of estate planning, trusts and probate services with additional expertise in both domestic and international business transactions and tax planning and tax controversy representation for individuals and companies.