In the first place, it is a “Domestic Self-Settled Spendthrift Trust” which is intended to allow an individual to create an irrevocable trust to hold assets that will be protected from her creditors. It is called a “self-settled spendthrift trust” because one can create a spendthrift trust to set aside protected assets while reserving certain beneficial interests in the assets – in essence allowing one to part with control of assets while not “giving away” the assets completely.
It used to be this was not possible, and many planners would set up offshore asset protection trusts to achieve a similar result until Alaska became the first state in 1997, followed by Delaware, to adopt laws permitting individuals to avoid creditors’ claims by adopting such trusts. Virginia joined the parade in 2012 and there are now 15 states that have such statutes.
The central objective of a self-settled spendthrift trust is to protect the trust’s assets from creditors’ claims through application of the trust’s “spendthrift” provision, which is commonly found in estate planning trusts to protect the trust assets from creditors of beneficiaries other than the maker of the trust, who is often called the “Settlor”. There can also be an estate tax planning aspect to self-settled spendthrift trusts, under which the Settlor may provide that the assets in trust will not be in the Settlor’s taxable estate at death. Such trusts can also be used to control assets in a manner that protects them from waste by the Settlor or other trust beneficiaries.
Many individuals look for ways to protect their assets, particularly if they are engaged in business or other activity that exposes them to personal liability. Litigation verdicts today often result in claims of millions of dollars. I often have successful business people who wish to protect hard-earned after tax assets from such liability inquire about putting all assets in trust to protect against creditors’ claims. It is not unusual today for estate planning to include a revocable trust which will hold all of the client’s assets in order to establish seamless administration of assets in the event of mental incapacity, and clients wonder whether the trust can also protect against creditors’ claims. The short answer is no! The longer answer may be to seek protection under an irrevocable self-settled spendthrift trust.
Self-settled spendthrift trusts must meet strict statutory requirements to provide effective protection, and this differs from state to state, although they are generally similar. However, the level of protection from the spendthrift provision varies from state to state, so it is important to evaluate the Settlor’s wishes against the variations among different state statutory schemes. One common thread is that the strategy generally will not work to protect assets transferred to the trust with intent to hinder, delay or defraud creditors. Under Virginia law, assets transferred into the trust will not be protected against claims of existing creditors or if the Settlor was insolvent or would be rendered insolvent by the transfer, and no fraudulent intent need be established. In addition, certain claims for child support or maintenance, payment for services for the protection of a beneficiary’s interest in the trust and claims by federal , state and local governmental agencies are not completely protected.
Other critical requirements of Virginia law are that (i) the trust be irrevocable, (ii) it be created during the Settlor’s lifetime and not by the Settlor’s Will, (iii) there be at least one other beneficiary entitled to receive the same types of distributions as the Settlor, (iv) there be at least one “qualified” trustee who is a Virginia resident and maintains the trust in Virginia and is not subject to direction of another person who would not meet such requirements, (v) the trust provide that Virginia law governs, (vi) the trust contain a spendthrift provision that restrains both voluntary and involuntary transfers of the Settlor’s interest in the trust, and (vii) the Settlor not be granted the right to disapprove distributions from the trust. In addition, the trust must provide that any distributions to the Settlor are in the sole discretion of an “independent” qualified trustee whose actions are not subject to direction by the Settlor, certain relatives or certain business entities or subordinate employees.
Assets may be transferred to the trust when it is formed and from time to time thereafter and the tests described above as to whether the transferred assets will be protected is generally applied as of the time of transfer. Creditors must bring claims challenging the trust’s protection of transferred asset within five years of the transfer into trust.
Is this planning strategy appropriate for everyone who wishes to protect hard earned assets from creditors? It certainly will not work for a Settlor who is attempting to avoid known creditor claims, or who is insolvent or rendered insolvent at the time assets are transferred to the trust. Nor is it appropriate for a Settlor who wishes to retain control of her assets. In any event, it may not be appropriate or necessary to place all of one’s assets into an irrevocable lifetime trust. In addition, there are significant associated costs for fees of a qualified trustee and independent qualified trustee and the general costs of administration, but those may be largely present with any irrevocable trust and often with lifetime revocable trusts.
However, it may be an appropriate planning tool for one who has a large and/or expanding estate who has no current creditors/claims or anticipated claims and may consider placing some portion of her assets, perhaps appreciating assets, in the hands of an independent trustee. This can be an important component of an overall estate plan that is put away and protected to serve as a source of wealth and support in the future. Taken together with other wealth preservation strategies such as carrying extensive liability insurance, holding property as tenants by the entirety, gifting, and family limited liability companies/partnerships, a strategically designed and funded self-settled spendthrift trust may be worth considering.
DiMuro Ginsberg is a litigation law and business law firm located in Alexandria, Virginia. The firm’s practice focuses primarily on general and complex litigation in the areas of corporate and commercial law, intellectual property, business torts, RICO, criminal law, white collar crime, employment law, professional liability and ethics and business law. Tom Hicks is the Chamber’s General Counsel and heads the corporate, business and estate planning practice of DiMuroGinsberg, PC, working with business owners in organization, governance and eventual disposition of their businesses.