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Trust Law/Level VI · Protection/6.1 Spendthrift to self-settled/Lesson 4

Asset protection trusts in general

The features asset protection trusts commonly share, at home and offshore, and the limits no drafting can remove: existing creditors, voidable transfers and bankruptcy.

Education, not legal advice. Trust law changes from country to country and state to state, and the right structure depends on your situation. Anything you sign should be drafted or reviewed by a qualified lawyer where you live.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. The cheapest protection needs no trust: homestead, retirement-plan and insurance exemptions plus an umbrella policy cover most households before any trustee fee. Catch: exemptions vary by state, and state exemptions generally do not limit federal tax collection (IRC §6321).
  2. Receive inheritances in a third-party discretionary spendthrift trust drafted by the giver, protected under UTC §§502 and 504 at no cost to the beneficiary. Catch: if one person is sole trustee and sole beneficiary, title merges and the trust ends.
  3. If a self-settled trust is used, keep an independent trustee, purely discretionary distributions and no settlor control; in FTC v. Affordable Media (1999) settlors who stayed protectors were held in contempt. Catch: UVTA undoes transfers made to hinder any present or future creditor.
  4. Budget running costs honestly: trustee fees, legal and tax work, and for offshore trusts Forms 3520 and 3520-A, FBAR and Form 8938 every year. Catch: an unreported transfer to a foreign trust costs the greater of $10,000 or 35% (IRC §6677).

MaterialsLesson 6.1.2, on third-party and self-settled trusts, and lesson 6.1.3, on domestic asset protection trustsThe text of 11 U.S.C. §548, free on law.cornell.edu, especially subsection (e)The Uniform Law Commission’s page on the Uniform Voidable Transactions Act (2014)Lesson 6.2.2, on the Cook Islands and the offshore model, for the offshore detail this lesson leaves out

Wonder

  1. What do domestic and offshore asset protection trusts have in common?
  2. Why can a trust not protect assets from a creditor the settlor already owes?
  3. What does it cost to keep such a trust working?

Explore

  1. An asset protection trust is an irrevocable trust designed so that a beneficiary’s interest, often including the settlor’s own, is hard for creditors to reach. It rests on the trust’s basic split: the trustee holds legal title and the beneficiaries hold the beneficial interest. A trust is not a separate legal person; a beneficiary’s creditors are held back because the trustee holds the property under the trust’s terms, not because a new owner exists. If one person is sole trustee and sole beneficiary of all present and future interests, legal and beneficial title merge and the trust ends.
  2. Most such trusts share a set of features. A spendthrift clause bars the beneficiary from assigning the interest and bars creditors from reaching it before it is paid out; in US states it is generally enforced (UTC §502 where enacted), while in England and Wales a restraint on alienation of a life interest is generally void (lesson 3.2.6). Distributions are left to the trustee’s discretion, since a mandatory right to payment is easier for a creditor to reach (UTC §§504 and 506). And the trustee is independent of the settlor, because a settlor who controls the money may be treated as owning it.
  3. Many also name a protector, a person who can remove and replace the trustee or veto certain acts, and offshore trusts often add a duress clause, telling the trustee to ignore instructions given under court compulsion, and a flight clause, letting the trustee move the trust to another country. These clauses have limits: in FTC v. Affordable Media (9th Cir. 1999), the settlors were also the trust’s protectors, a US court held them in civil contempt when the assets were not brought back, and the Ninth Circuit upheld the finding that they still controlled the trust. Lessons 6.2.2 and 6.2.3 cover the offshore model and these clauses.
  4. Self-settled trusts raise the hardest problem. In most US states, under UTC §505 or the common law, a settlor’s creditors can reach whatever the trustee could pay to the settlor, spendthrift clause or not. A minority of states allow domestic asset protection trusts as an exception, beginning with Alaska and Delaware in 1997 and Nevada in 1999 (lesson 6.1.3). Federal bankruptcy law adds a separate limit: under 11 U.S.C. §548(e), added in 2005, a bankruptcy trustee can avoid transfers to a self-settled trust of which the debtor is a beneficiary, made within 10 years before the filing with actual intent to hinder, delay or defraud a present or future creditor.
  5. Voidable transfer law is the main limit. The Uniform Fraudulent Transfer Act (1984), renamed the Uniform Voidable Transactions Act in 2014, lets a creditor undo a transfer made with actual intent to hinder, delay or defraud any creditor, whether the claim arose before or after the transfer, and some transfers made without fair value while insolvent, without proof of intent. So a trust funded after a claim exists, or when one is foreseeable, is exposed, and courts can add consequences such as contempt or, in bankruptcy, denial of a discharge. Lessons 6.3.1 to 6.3.4 cover these rules, the badges of fraud and timing.
  6. Asset protection trusts also carry ongoing costs: trustee fees, legal and accounting work and, for offshore trusts held by US persons, information reporting such as FBAR and FATCA (2010) filings (lesson 6.2.4). Costs vary widely by place, complexity and adviser, and this course gives no typical figure. Published court decisions mostly record failures; trusts that are never challenged leave no court record, so the case law does not show how often such trusts succeed. This lesson describes how these trusts work and where they fail; it does not suggest creating one.

Key facts

  • Common features of asset protection trusts are an independent trustee, discretionary distributions and a spendthrift clause; many add a protector, and offshore trusts often add duress and flight clauses.
  • In England and Wales a restraint on alienation of a life interest is generally void, unlike US spendthrift clauses under UTC §502.
  • Under UTC §505, a settlor’s creditors can generally reach what the trustee could pay to the settlor from a self-settled trust, except where a state’s domestic asset protection trust law provides otherwise.
  • Alaska and Delaware enacted the first domestic asset protection trust statutes in 1997; Nevada followed in 1999.
  • 11 U.S.C. §548(e) lets a bankruptcy trustee avoid transfers to a self-settled trust made within 10 years with actual intent to hinder, delay or defraud.
  • Under the Uniform Voidable Transactions Act (2014; formerly the UFTA, 1984), a transfer made with actual intent to hinder, delay or defraud can be undone by creditors whose claims arose before or after it.

Exercise nine, six, three, one

9CollectList up to 9 features of an asset protection trust you are reading about, in a lesson or a court case (some lists are shorter), such as who is trustee, who may benefit, what the spendthrift clause says, whether there is a protector, which law governs and when it was funded.
6ClusterSort them into 6 categories: roles and control, distribution terms, spendthrift and duress terms, governing law and location, timing of funding, and facts you are unsure about.
3DistillReduce the 6 categories to 3 groups: features meant to support protection, features a court could use to treat the assets as the settlor’s, and questions you would ask an adviser about.
1CrystallizeWrite 1 sentence explaining, in your own words, why no trust feature protects assets transferred with intent to hinder, delay or defraud a creditor.

Fact check

Dates, figures and claims checked against the published sources listed below.

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