Asset Protection and Practical Uses of Self-Settled Grantor Trusts

At Apexium, we take a comprehensive and holistic approach to estate planning. This entails helping our clients understand who will inherit their assets, and how. Moreover, we clarify what taxes will be attributable to each asset, who will pay such taxes, and craft a plan so that the cash will be available to the responsible party.

Apexium’s relationship managers, when crafting an estate plan, incorporate asset protection, which should be a vital component of a client’s overall strategy.

According to Apexium Partner David Bruckman, trusts are frequently employed in designing an asset protection plan, especially for those assets that do not offer any inherent asset or creditor protection. For example, most retirement plans and cash value life insurance offer some element of creditor protection, whereas cash and investments individually owned typically do not, and are thus subject to creditors’ claims.

Traditionally, when clients use a trust for asset protection, the client is the grantor (the creator) of the trust who transfers assets to the trustee for the benefit of somebody else, such as a spouse, or children (the beneficiaries). The trustee of the trust controls the assets, so the assets are generally protected from the future creditors of the grantor and the beneficiaries. This is especially the case if the beneficiaries have no legal right or ability to demand distributions of income or principal from the trust. Such a trust usually has a spendthrift provision which protects the trust’s assets by denying the beneficiary any ability to assign or access the assets of the trust. Consider, however, the circumstance where the client is not concerned about protecting assets from future creditors of his or her children, but rather his or own creditors, and still wants to have use of the money for him/herself in the event of a future need. This is where the use of a so-called, self-settled grantor trust might be the answer.

A self-settled trust is created by the client for his/her own benefit, or by another person, and is funded by the client. The client is the beneficiary of the trust. Only the legal title of the trust’s assets is transferred to the trustee, who is not the client, thereby protecting the trust’s assets from future creditors of the client. The goal of the client is to “have his cake and eat it too.” Multiple offshore jurisdictions, and approximately 15 states in the U.S., have statutes permitting such an arrangement. Such states include, notably, Delaware, Alaska and South Dakota. Ostensibly, such statutes were enacted in order to attract trust business. This is because the trustee must be based in a state under which the trust is formed. Most states, however, have not enacted such legislation.

New York, for example, has a policy against self-settled trusts, so such a trust created in New York, even if it has a spendthrift provision, will not offer creditor protection as to the creditors of the client. New York judges, however, should respect the laws of another state. Thus, a New York resident might create a Delaware self-settled grantor trust for asset protection. This would probably entail employing a Delaware bank or trust company to serve as the independent trustee. The client’s expectation is that the trust’s assets will be protected from his or her future creditors, but that the trustee would make distributions to the client if the client so desired. The expected protection, however, is not ironclad, as the law is unsettled. It is unclear whether a New York court, or court of a similar state that does not recognize self-settled grantor trusts, will apply the law of New York State to invalidate the trust or the law of the jurisdiction where the trust was formed.

For residents of states that do not afford third-party creditor protection of self-settled trusts, it does not mean that such trusts lack asset protection value. Such value, however, is to protect the grantor from himself or herself, rather than protect the trust’s assets from the grantor’s future creditors. Consider the following example, a granddaughter, who is 22, inherits a significant sum of money from a relative. The Parents of the granddaughter feel that not only is she too young to responsibly handle the money today, but that her wild side might result in her squandering the money down the road. Regrettably, the money was not left IN TRUST for the benefit of the granddaughter (which would have been an example of good planning), but rather bequeathed to her outright. A planning strategy using a self-settled grantor trust is for the parents to “convince” the granddaughter to transfer the inheritance to the trust. Assume a parent(s) is the trustee and the granddaughter is the beneficiary. The trustee would have sole and complete discretion regarding distributions from the trust to or for the benefit of the granddaughter, and the trust would have to request spendthrift provisions. Thus, while in a state like New York, the creditors of the granddaughter could attack the trust, and the granddaughter cannot access the assets.

Of course, it is infrequent that a minor unexpectedly inherits a significant sum of money. A more popular application of a self-settled trust is where a child who is approaching emancipation (typically age 21 under state law) will become the owner of a UGMA or UTMA account. These accounts, the advent of 529 plans notwithstanding, are still prevalent. Sometimes, the parent of the child is concerned, or even horrified, about the notion that the child will become the owner of the UTMA account. A solution to employ is for the parent or other relative to convince the child that contributing the UTMA assets to the self-settled trust is in the child’s best interest. The child is the sole beneficiary of the trust but a parent, as trustee, will control the money until the child attains a suitable age.

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Apexium is not a law firm, does not draft legal documents and does not render legal advice.