Are Irrevocable Trusts “Irrevocable”?
By Laura Wilensky
Irrevocable trusts play a key role in many estate planning strategies. The word “irrevocable” understandably leads people to believe that these trusts cannot be changed under any circumstances. Shifting family dynamics, evolving financial needs, or changes in the law, however, may create a need to make changes to an irrevocable trust. While the term “irrevocable” suggests permanence, there are several legal tools that allow for alteration of an irrevocable trust, including (1) statutory modification of the trust, (2) decanting assets from one trust into another, and (3) merging trusts with similar terms. These mechanisms not only help address changed circumstances but can also resolve tax issues or administrative challenges—making an “irrevocable” trust less rigid than its name implies.
This article is the first of a three-part series that will discuss these three options and will focus on the modification of noncharitable irrevocable trust under New Jersey’s counterpart of the Uniform Trust Code (UTC).[1] We will outline the key considerations when modifying a trust, including beneficiary consent, fiduciary duties, the application of representation statutes, and the steps required to obtain court approval (if necessary), and discuss the potential gift tax consequences.
Modification of an Irrevocable Trust
Under N.J.S.A. §3B:31-27(a), a noncharitable irrevocable trust governed by New Jersey law may be modified or terminated with the consent of the trustee and all beneficiaries, provided that the modification or termination is not inconsistent with a material purpose of the trust. To modify a noncharitable irrevocable trust under N.J.S.A. §3B:31-27(a), two conditions must be met:
- Consent: All beneficiaries and trustees must agree to the modification.
- Preservation of Material Purpose: The proposed change must not be inconsistent with a material purpose of the trust.
- Consent of the Trustees and Beneficiaries
The trustees and all “beneficiaries” of the trust must consent to the proposed modification in order to modify a trust without court approval. A “beneficiary” is defined by N.J.S.A. §3B:31-3 as any individual who:
- Has a present or future interest in the trust, vested or contingent;
- Holds a power of appointment over trust property; or
- Is the owner of an interest in the trust by assignment or other transfer.
This definition includes all categories of beneficiaries - those that are currently receiving or permitted to receive trust distributions, those who will or may receive them in the future, and those who will receive trust benefits if neither present nor future interest holders survive. N.J.S.A. §31:3B-27 therefore ensures that not only present and future interests, but also contingent interests, are protected if a trust is to be modified.
Some of these beneficiaries may be minor, incapacitated, or unborn individuals. Nevertheless, their interests must still be represented in order to modify an irrevocable trust without court approval, creating significant logistical challenges. For example, obtaining consent from a minor or incapacitated person may require the appointment of a guardian ad litem or court approval. New Jersey’s representation statutes (N.J.S.A. §§3B:31-13 through 3B:31-17) create a mechanism for one party, such as a parent, guardian, fiduciary, or a beneficiary with a substantially identical interest, to represent and bind another, so long as no conflict of interest exists.
If a beneficiary withholds consent to a proposed modification, a modification may still be achieved by obtaining court approval. N.J.S.A. §3B:31-27(b) permits a court to approve a modification, provided that the court is satisfied that (1) if all beneficiaries had consented, the trust could have been modified nonjudicially and (2) the interests of each beneficiary that does not consent will be adequately protected.
- Material Purpose of the Trust
Under N.J.S.A. §3B:31-27, the modification cannot be inconsistent with a material purpose of the trust, whether the trust modification is to be done nonjudicially or with court approval. The commentary to the UTC provides that the purpose is considered “material” if the purpose is significant and central to the settlor’s intent. Material purposes are not readily inferred and require more than a general understanding of the trust’s structure. Courts look to the specific concerns or objectives expressed by the settlor, such as protecting a beneficiary from poor financial judgment, immaturity, or external risks. Protective features, such as delayed payouts or limits on spending, often show the trust was meant to protect or guide the beneficiary, which is often the settlor’s material purpose. Importantly, N.J.S.A. §3B:31-27(c) provides that a spendthrift provision[2] is not presumed to constitute a material purpose of a trust and its existence in a trust will not inhibit a trust modification. When the trust instrument does not explicitly identify material purposes, courts may rely on circumstantial evidence to discern the settlor’s intent. This includes the nature of the interests created, the language of the trust, and the context surrounding its formation.
Common examples of material purposes include tax savings, asset protection and control, and preservation of family assets. Trusts created to achieve estate, gift, or generation-skipping transfer tax savings often embody a material purpose. For instance, a trust structured to preserve the settlor’s unified credit or to hold assets outside the taxable estate may not be modified if doing so would undermine those tax benefits. Trusts that delay distributions until a beneficiary reaches a certain age or milestone (e.g., graduation, sobriety, marriage) reflect the settlor’s concern about maturity or judgment, which courts often recognize as material. Lastly, trusts created to retain ownership of a family business, real estate, or legacy assets across generations may have a material purpose in maintaining continuity and control.
Fiduciary Duties of the Trustee
The party seeking the modification (e.g., a beneficiary or a trustee) should also consider the impact on the trustees’ fiduciary duties. Trustees have fiduciary duties of loyalty and impartiality, requiring them to act in good faith and consider the interests of all beneficiaries. When evaluating a proposed modification to the trust, trustees must ensure that the change is fair to all beneficiaries and does not place any party at an unfair disadvantage. A trustee who supports a modification must be prepared to demonstrate that the decision aligns with the trustee’s fiduciary obligations and does not expose the trustee to liability for breach of trust.
Possible Gift Tax Consequences
It is important to consider not only the requirements of New Jersey law but also the potential federal gift tax implications of trust modification.
In Chief Counsel Advice Memorandum 202352018 (Dec. 29, 2023) (“CCA 202352018”), the Internal Revenue Service (the “IRS”) examined whether a trust modification could result in a taxable gift. The modification in that case was completed in accordance with state law with the consent of the trustee and all beneficiaries. The modification added a tax reimbursement provision that would allow the trustee to distribute trust income and principal to reimburse the settlor for any income tax liability of the settlor attributable to the inclusion of the trust’s income in the settlor’s taxable income.[3] The IRS concluded that if a beneficiary surrenders, reduces, or otherwise alters the beneficiary’s beneficial interest in a trust by agreeing to a modification, that beneficiary may be treated as having made a taxable gift to the other beneficiaries. The analysis relied on the principle that a gratuitous transfer of property rights without full and adequate consideration constitutes a gift under Internal Revenue Code §2501.
Thus, when a beneficiary consents to a change that diminishes the value of the beneficiary’s interest, the IRS may characterize that diminution as a taxable gift to the individuals who benefit from it. In such cases, the consenting beneficiary may need to file a federal gift tax return to report a gift which is equal in value to the interest given up. The IRS distinguished this situation from modifications that are purely administrative in nature, such as updating trustee powers, modernizing investment authority, or clarifying procedural provisions. If a beneficiary’s economic interest is not affected, no taxable gift arises.
While the New Jersey UTC provides the mechanisms for modifying irrevocable trusts, federal tax law must be part of the analysis. Any modification that changes a beneficiary’s interest can have federal gift tax consequences that must be understood.
Conclusion
Modifying an irrevocable trust under New Jersey law provides valuable flexibility when circumstances change, but it requires careful attention to statutory requirements, fiduciary duties, and potential tax implications.
In the next installment of this three‑part series, we will examine trust decanting, which is the process of “pouring” assets from one trust into another trust. The article on decanting will be followed by an article about trust mergers which will explain how and when multiple trusts with similar terms can be combined into one trust to simplify administration and improve efficiency.
[1] The Uniform Trust Code (UTC) is a model law drafted by the Uniform Law Commission to standardize trust laws across the U.S. and provide clear rules for the creation, administration, and termination of trusts. New Jersey enacted its version of the UTC on January 19, 2016, and it became effective on July 17, 2016.
[2] Under N.J.S.A. §3B:31-36, a valid spendthrift provision restricts a beneficiary’s ability to voluntarily or involuntarily transfer the beneficiary’s interest in the trust and may protect the beneficiary’s interest from the reach of creditors.
[3] Under the Internal Revenue Code, the existence of certain terms and provisions in a trust can cause the trust’s income to be taxable to the trust’s settlor, rather than the trust itself.