21 Nov Drafting Trusts to Keep Away Unwanted Beneficiaries
For assets that don’t have a special exemption (e.g., homestead exemption in the settlor’s home state), transfer to a self-settled trust or a traditional trust with special provisions can be a severe impediment to both creditors and unintended beneficiary claimants.
The type of trust offering the greatest protection from unwanted claims is called both a domestic asset protection trust (DAPT), a type of self-settled trust. Self-settled trusts are distinguishable from more traditional trusts because they allow their settlors to retain a beneficial interest in the trust; however, most states do not allow for self-settled trusts. And, of the states that allow the beneficiary to retain a trust interest, only a handful have adequate statutory language to make it worthwhile to form a DAPT. The leading DAPT states are Nevada, South Dakota, Alaska and Delaware. In these states, DAPTs are flourishing.
Even In states that don’t allow for DAPTs, there are steps that can be taken to maximize trust asset protection. The most common drafting technique is to include spendthrift provisions in every protective trust. A “spendthrift provision” in a trust protects a beneficiary from assigning away his or her inheritance and also protects against a creditor attaching the beneficiary’s inheritance.
Another valuable strategy is to give the trustee “discretionary” power to make distributions in the best interests of the beneficiaries. This strategy is effective because, in most cases, the creditor of a beneficiary can’t compel the trustee to pay any amount that is payable only in the trustee’s discretion. Contrarily, trusts that provide for the “support of the beneficiary” give the beneficiaries a legally enforceable interest in receiving distributions. While this may sound good to a beneficiary, it will likely make the beneficiary’s distributable interest subject to his or her creditors.
Mandatory distribution trusts require the trustee to make distributions to a given beneficiary, as set forth within the trust agreement. The trustee has no discretion to withhold a “mandatory distribution,” no discretion to “spray” the distribution among a class of beneficiaries and little to no ability to control the amount or timing of the distribution. Trusts that provide for mandatory distributions are even more open to a beneficiary’s creditor claims than support provisions and should be avoided if protection is a consideration.