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Tuesday, January 27, 2015

Asset Protection: Self-Settled Trusts vs. New York Based Trusts

The goal of asset protection planning is to insulate assets from claims of creditors without concealment or tax evasion. Many people get sued. Some are in professions that almost seem to invite litigation (doctors, lawyers, business owners, home owners). Others simply get unlucky (i.e. car accident). If one is already getting sued, then it’s too late to protect the assets. Any transfers that get made after a creditor is known may be considered fraudulent conveyance and may be invalidated. The time to plan and protect the assets is before the debt or the creditor exists.

When it comes to asset protection from future creditors, there are 2 broad categories of trust options available: self-settled trust (based outside of New York State) and New York-based trusts.

Self-Settled Trusts:

What is it:  An irrevocable trust formed under the law of one of the 14 states in the United States that permit these types of Trusts. The Grantor is a beneficiary of the Trust.

  • The States that permit the self-settled trusts are: Alaska, Colorado, Delaware, Hawaii, Missouri, New Hampshire, Nevada, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, Wyoming.

Main features:

  1. The grantor of a self-settled asset protection trust irrevocably transfers assets to a trust under which he or she is a beneficiary.  The trust must also contain contingent beneficiaries of trust income and principal.

  2. An independent trustee controls all trust distributions. The Trustee must be based in the state under which the Trust is formed.

  3. The trust must contain a spendthrift provision, prohibiting the grantor and his creditors from accessing the trust’s assets.

  4. The grantor cannot have the ability to amend or revoke the trust. Often, however, the grantor retains a limited power to appoint the trust assets to persons and / or charities of grantor’s choosing at death.

Benefits:

  1. The Grantor can receive money from the Trust. This is one of the key features that make these trusts so desirable to individuals who are reluctant to part with their assets. Even though the Trust is irrevocable, the assets that are placed into it can ultimately be given back to the Grantor.

  2. Asset protection. Various states have different time periods during which the creditors can act after the asset transfer. For example, a Nevada trust has a 2 year statute of limitations – if the creditor pursues a claim 2 years after the debtor transferred his property into the trust, the assets cannot be recouped.

  3. Note, however, that if the debtor declares bankruptcy, the bankruptcy court has a 10 year statute of limitations for asset claw back.

 Drawbacks:

  1.  The Trustee must be based in the jurisdiction under which the Trust is formed. This may be a significant problem for individuals who have no relationship to the state, and who have will have a complete stranger (or a corporate entity) control the distributions to them.

  2. Some creditors still have priority. Depending on the state, there are certain categories of creditors that are exempt from the asset protection features of these trusts (child support claims, claims from divorcing spouses and / or alimony, torts, etc.)

  3. The asset protection from general creditors may also be limited. There are very few court cases that test the validity of these trusts. Lately, however, there have been several bankruptcy cases that invalidated the asset protection features of self-settled trusts.

  4. New York has a policy against self-settled trusts and does not permit their creation in New York. However, New York must respect the laws of another state, therefore there are many of these trusts done by New York residents, in the hopes that their assets will be protected.  Yet it is unclear whether, when the creditor sues, New York courts will apply the law of the New York State (and invalidate the trust) or the law of the jurisdiction where the trust is formed.

  5. Cost. It is much more expansive to create and run a ‘foreign-based’ trust than a domestic trust.

Domestic Trusts:

What is it: An irrevocable trust that is formed in the New York State and governed by the New York State laws. The Grantor cannot be a beneficiary of the Trust.

Main features:

  1. The Trustee can be anyone, including the Grantor’s family member (although the spouse of the Grantor should not be the Trustee if asset protection is the reason for the creation of the Trust).

  2. The beneficiaries are usually the Grantor’s spouse and children. But the Trust can be for the benefit of anyone that the Grantor desires, including other family members, friends and charities.

  3. Can contain a spendthrift provision, but since the beneficiaries are people other than the Grantor, this provision will apply to them alone.

Benefits:

  1. These trusts have been tested multiple times in New York courts and are valid as an asset protection tool.

  2. The Trustee can be a local individual with whom the Grantor can have a relationship (a sibling, an uncle, a grandparent).

  3. Cost. It is much cheaper to create and to administer a domestic trust.

Drawback:

  1. The Grantor cannot be the beneficiary of the trust. This is a very hard decision to make for a lot of individuals. Once the transfer of an asset to the trust is made, it is an irrevocable decision and the asset cannot be given back to the Grantor.

     

Common feature: For both domestic and foreign trusts, the transfers cannot be fraudulent, meant to hinder or delay a creditor. Therefore, if there are known creditors and the transfer to the trust would make the Grantor insolvent, the assets are likely to be clawed back.

This article only offers general information.  Each situation is unique. It is always helpful to talk to a specialized attorney, to figure out your various options and ramifications of actions.  As every case has subtle differences, please do not use this article for legal advice. Only a signed engagement letter will create an attorney client relationship.


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