Trusts can serve many purposes, from transferring wealth to furthering philanthropic goals. If asset protection is a priority, a wasteful self-established trust can be a valuable tool for wealthy individuals and their families.
Spendthrift self-established trusts, often called self-appointed trusts, have become increasingly popular for those who want to protect their assets from future creditors (or future exes). A self-established trust is a type of irrevocable trust in which the grantor is also the primary beneficiary.
To maximize the trust’s utility in protecting the grantor’s assets, its structure should prohibit the grantor, or its creditors, from accessing the trust assets. This feature is known as the wasteful provision, from which the trust takes its name. An independent trustee controls all trust distributions. The trustee can, and often does, make distributions to the grantor; however, the trustee is not required to do so unless he deems it appropriate. This provides the trustee the flexibility to stop distributions in the event a creditor or former spouse files a claim against the grantor.
While this can be a valuable fix for a person concerned with asset protection, it cannot be done in retrospect. The rules prevent the creation of a self-established trust expressly to hinder or defraud existing creditors. Only 14 states specifically allow the creation of such trusts, and the rules for how existing creditors can react vary by state.
Nevada is a popular jurisdiction for the creation of self-established splurge trusts due to an unusually short period in which creditors can act. In Nevada, a grantor’s known creditors have a two-year window from the creation of the trust or a six-month period after they discover a transfer of property (or should reasonably have discovered the transfer), during which they can challenge any transfer of ownership in a self-established trust. In many other states, including Alaska, Delaware, and Rhode Island, a creditor has up to four years to contest a transfer, leaving the grantor exposed for a longer period.
As long as you are not subject to any creditor claims at the time the trust is created, you can protect the assets from future creditors by transferring them. Assets in a self-established trust will generally be protected should a future claim arise. This can be particularly attractive to those who face a higher likelihood of personal lawsuits stemming from their professions, such as doctors, lawyers, or business owners.
Of course, like everything in life, nothing is guaranteed. As mentioned above, any indication of a transfer to the trust in response to or in anticipation of creditor claims will put the trust assets at risk. Additionally, there are other actions by a grantor that will be viewed unfavorably by courts, such as making a transfer to the trust that renders the grantor insolvent. A recent bankruptcy case in Seattle suggests that judges in some jurisdictions may even try to ignore seemingly valid trusts.
While self-established trusts are primarily designed for asset protection, they can also be useful vehicles for wealth transfer if properly structured. For example, a person with an estate of $8 million wants to take advantage of the current $5.25 million lifetime gift tax exemption, but is concerned that the remaining $2.75 million will not be enough to support him for the rest of his life. . You could make a gift of $5.25 million to a self-chartering trust, designating yourself as one of several beneficiaries and assigning an independent trustee who would have the ability, but not the obligation, to make distributions to the grantor over its lifetime. Upon the grantor’s death, the remaining trust assets, including any goodwill, would pass to the other beneficiaries free of estate taxes. Those interested in making large wealth transfers to younger generations, but fear they may still need the assets, may be willing to use a self-established trust with this added flexibility.
Self-established trusts provide many obvious benefits, but they also have some drawbacks. Most important is the power of the independent trustee over the distributions and the inability of the grantor to compel the trustee to make them. Coupled with the fact that the trustee must reside in the state where the trust is created, this can make it difficult for grantors to find suitable trustees. For example, if someone wanted to take advantage of the Nevada rules governing self-established trusts but did not know of any suitable Nevada residents who could serve as trustee, then they might need to rely on a trust company or financial institution with which they had no prior history to make distribution decisions. Understandably, this situation may make the idea not a good start for some.
Additionally, self-established trusts are irrevocable. Once the assets are transferred, they cannot be transferred back to the trust creator, except as a distribution to him as the beneficiary. This only becomes a problem when the trustee chooses not to make distributions, but such a decision is within the rights of the trustee. Therefore, again, it is vital that the trustee be someone the grantor respects and trusts to properly manage their assets.
Self-established trusts are a relatively new estate planning vehicle. This has led some to question its viability, particularly for people who live in jurisdictions that do not allow its creation but establish one elsewhere. For example, if a grantor in New York established a self-established trust in Nevada, the claimant would have to file the claim there. If Nevada rejects the claim, the claimant could take action in New York in an attempt to have Nevada’s ruling reversed. There is no long history of courts reviewing self-established trusts, so no one knows for sure what the outcome of such legal action would be. Also, that outcome could vary from state to state. Most planners recognize, however, that a properly structured self-established trust established under non-fraudulent circumstances creates some level of asset protection, as well as discovery for creditors, compared to outright asset ownership.
Although we have described them extensively in this article, in practice, self-established trusts are quite technical and should only be drafted by an experienced and knowledgeable attorney. Even states that allow wasteful self-established trusts have their unique statutes. It is imperative to understand the legal ramifications and risks of the decision before establishing the trust, an insight that only a professional can provide.
Despite the complications, the benefits of self-established trusts are clear. Self-established trusts offer the winning combination of asset protection and estate planning in one technique.
