Trusts are an important tool of estate planning for many reasons, one of which is the tax benefits associated with holding assets in a trust. Trusts are routinely set up as a planning tool and contain various different provisions about how and when trust assets are distributed to the qualified beneficiaries of the trust. Trustees can have different ranges of power depending on the terms of the trust instrument, and the extent of the discretion afforded to the trustee dictates what they are able to do with the trust assets. Trustees with a discretionary power to distribute trust assets may do just that – distribute the assets to the qualified beneficiaries. Trustees with a special power of appointment have greater rights and can have the right to invade the principal of the trust. Giving a trustee a power of appointment, especially an absolute power of appointment, can allow the trustee to distribute assets in ways that can be extremely advantageous to the qualified beneficiaries.
Can a trustee of a trust distribute the principal of a trust to a new trust that may have different terms? The answer is yes, provided certain conditions are met. When a trustee with the discretion to distribute the principal of the trust uses that discretion to distribute the principal into a new trust, it is called “decanting the trust.” Trust decanting is a means of planning that helps beneficiaries retain the tax benefits of a trust. The reason decanting is allowed is that if the trustee, through his power of appointment, has the ability to distribute property to the beneficiaries or for their benefit, then that power of appointment should allow the trustee to distribute property into a second trust for the benefit of the qualified beneficiaries.
In Florida, trust decanting was originally allowed by common law. In 1940, the Florida Supreme Court decided Phipps v. Palm Beach Trust Co., 142 Fla. 782 (1940). In Phipps, a wife created a trust that named her husband as the primary beneficiary and gave him a power of appointment exercisable during his life, and in favor of her children after his death. Mr. Phipps directed the creation of a second trust in favor of the children. The trustee brought suit. The Phipps court held that the creation of the second trust was allowed because the trustee had a specific power to direct the distributions to trust beneficiaries. The trustee’s power was a power of appointment, not a discretionary power to distribute trust property. The holding, then, applies only to a trustee with a special power of appointment, not to a trustee with only discretionary power.
Florida Statute Section 736.04117 codifies the Phipps holding. The statute allows for a trustee who has absolute power to invade the trust principal to make distributions to a second trust if (1) the beneficiaries of the second trust include only the beneficiaries of the first trust and (2) there is no reduction in fixed income interest. Decanting can only be done by an instrument in writing, signed and acknowledged by the trustee, and filed with the documents of the first trust. The trustee is also required to notify all qualified beneficiaries of the first trust at least sixty (60) days prior to the decanting.
So, when it comes to decanting a trust, there are a host of factors that must be taken into account. First is the trustee’s discretion. The trustee must have the proper discretion to use the statute. The trustee cannot only have the power to distribute trust assets to, or for the benefit of, qualified beneficiaries, but has to have a power of appointment that allows for an absolute power of invasion of the trust principal. An absolute power is one that is not limited in any way by the trust instrument to specific or ascertainable purposes. Second, the beneficiaries of the second trust. The beneficiaries of the second trust can only be beneficiaries of the first trust. The trustee cannot distribute into a second trust with new beneficiaries. Third, the interests in the first trust cannot be changed. This means that the second trust cannot reduce any of the fixed income or other payments of the first trust. The second trust also cannot change any of the qualifications of the first trust, such as a trust qualified for the marital deduction. In addition to these requirements, the trustee must also notice all qualified beneficiaries of the decanting and make sure the decanting is done pursuant to a written instrument that meets the statutory guidelines.
Trust decanting is an easy way of distributing trust assets into a second trust in order to retain the tax benefits of holding those assets in trust. The legal team at Chepenik Trushin LLP can ensure your trust is structured so it can be decanted.