Self-settled trusts, also known as spendthrift trusts, are a specialized trust type permitted in select states. These trusts allow the person creating the trust (the grantor) to also be a primary beneficiary. Within this structure, assets become permanently held by the trust and under the control of an independent trustee, effectively removing them from the reach of most creditors. This legal tool empowers individuals in higher risk professions, such as business owners, physicians, and attorneys, to protect assets and their family’s livelihoods in the event of future litigation. Furthermore, self-settled trusts can strategically reduce the amount of assets exposed to federal estate taxes upon the grantor’s passing.

Comparison of Alaska, Nevada and Delaware Spendthrift Statutes

Alaska, Nevada, and Delaware all provide for self-settled spendthrift trusts. Good spendthrift statutes generally allow the grantor to set up an irrevocable trust, be a discretionary beneficiary and avoid having the assets be subject to creditor claims of either the grantor or another beneficiary.

Benefits of Self-Settled Trusts

• Asset Protection: The cornerstone of self-settled trusts is their spendthrift provision, which erects a formidable barrier when properly drafted. This provision shields trust assets from potential future creditors, including former spouses. This protection remains intact as long as the grantor does not face existing or foreseeable creditor claims at the trust’s inception. While trustees typically make distributions to grantor beneficiaries, they retain their independence and are not bound to do so. In certain jurisdictions like Alaska, Nevada, and Delaware, trust laws solidify creditor protection for self-settled trusts, granting the grantor a degree of control and disposition rights. Trustees may halt distributions at any time, as they may opt to do at times when beneficiaries are faced with some kind of creditor exposure.
• Transfer Tax Liability Reduction: Self-settled trusts offer an avenue to maximize the lifetime gift tax exemption while ensuring financial security for the grantor’s long-term needs. In this scenario, the grantor assumes the role of a beneficiary, receiving periodic distributions directed by the independent trustee. Upon the grantor’s passing, all remaining assets seamlessly transition to other beneficiaries without being subject to additional estate taxes. This has two major advantages: (1) the current lifetime gift exemption is maximized, even if there is a reduction in the federal lifetime transfer tax exemption limits at some point in the future, and (2) future growth of trust assets will happen outside of the grantor’s estate and thus, not subject to further estate or transfer taxation upon the grantor’s passing.

Important Considerations for Self-Settled Spendthrift Trusts

While self-settled trusts offer compelling advantages, several crucial considerations merit attention:

• Varied State Regulations: Fewer than one-third of U.S. states permit the establishment of self-settled trusts, and the regulatory landscape differs from state to state. Skilled legal counsel is crucial to ensure that the trust is properly drafted in the best state to achieve the goals of the grantor.
• Choice of Trustee: The grantor must select a trustee residing in the state where the trust is created.
• Limited Control: Grantors relinquish control over distribution decisions made by the independent trustee. This is a necessary component to ensure that the trust achieves the tax and creditor protection goals of the trust. If the grantor retains too much control over trust assets, it could be contended that the grantor still has access to those assets and as such, cause those assets to be considered property of the grantor, which then runs the risk of being reached by creditors or returned to the grantor’s estate. Following the advice of skilled legal counsel in this regard is crucial.
• Anti-Abuse Safeguards: Safeguards are in place to deter grantors from creating self-settled trusts with the intent of defrauding existing creditors. All top-tier trust jurisdictions have implemented safeguards in the law to prevent fraudulent transfers (fraudulent attempts to hide assets from pre-existing creditors).
• Risk of Regulatory Scrutiny: Trust assets may be at risk if courts suspect the trust was established in anticipation of creditor claims. It is important to take the necessary steps when establishing a self-settled to trust to demonstrate honest intent and ensure there is no danger of fraudulent transfer.
• Legal Consequences: Courts often view trust transfers that lead to grantor insolvency unfavorably. Some states, such as Alaska, have minimum requirements in statute to prohibit insolvency when creating a self-settled trust.

Note: The information provided here is for general educational and informational purposes only. It is not legal advice and should not be interpreted as such. For a thorough understanding of these topics relevant to your specific circumstances, we recommend consulting a qualified estate planning attorney. Peak Trust Company cannot provide legal advice; however, we can serve as an informational resource and provide referrals to highly skilled attorneys who can offer legal and tax guidance tailored to your specific needs.