How to Update Old Trusts

New legal tools are available to help many families stuck with out-of-date trusts.

For years I’ve warned against traditional trusts that make fixed distributions or distributions only from income. Inflation and the twenty year decline in interest rates and dividends have crippled the benefits from these trusts. Beneficiaries are helpless because the trusts are irrevocable and seemingly unchangeable.

A better strategy is the “total return trust? or unitrust. Distributions are a percentage of the trust value.

Fortunately, many states have come to the rescue. In 17 states trustees now are empowered to convert their trusts into total return trusts. In 35 states the trustee can adjust the trust to reclassify some principal as income, or vice versa. Only a small number of states allowed these powers as recently as 2001.

Trustees haven’t jumped at exercising these powers or letting beneficiaries know about them. One reason is potential tax problems. The IRS, however, changed the rules at the end of 2003 to eliminate some potential taxes. Trustees also are worried that the remainder beneficiaries will object to higher income payouts.

States that allow conversions are Alaska, Colorado, Delaware, Florida, Illinois, Indiana, Iowa, Maine, Maryland, Missouri, New Hampshire, New York, North Carolina, Oregon, Pennsylvania, South Dakota, and Washington. States allowing adjustments are Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, District of Columbia, Florida, Hawaii, Idaho, Indiana, Kansas, Louisiana, Maine, Maryland, Minnesota, Missouri, Montana, Nebraska, Nevada, New Jersey, New Mexico, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Tennessee, Texas, Virginia, Washington, West Virginia, and Wyoming.

Beneficiaries of traditional trusts with low income payouts should meet with their trustees and discuss the options under these laws. Often, all beneficiaries and the trustee must agree to a change. If your state does not have a favorable law, look into changing the trust’s location to a state with more desirable laws.