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Self-Settled Spendthrift Trust

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Self-Settled Spendthrift Trust: More Than Meets the Eye

Sisi C. Tran, Esq., Director of Trust & Estate Planning

What is a Self-Settled Spendthrift Trust?

Definition

In general, a “spendthrift trust” is a trust which prohibits a beneficiary and his or her creditors from reaching

trust assets contrary to the trust terms. A

self-settled

spendthrift trust (or more commonly called a self-settled

trust) is a spendthrift trust which includes the “Settlor” of the trust as a

beneficiary

of the trust. There are only

a handful of states which permit self-settled trusts—meaning, if such a trust is established by the Settlor in a

jurisdiction which

does

not

recognize self-settled trusts, then the Settlor’s creditors will be able to reach the

trust assets.

At its core, the self-settled trust is an asset protection trust.

Common Ingredients for Establishing a Self-Settled Trust

While each jurisdiction permitting self-settled trusts has its own specific statutes, this type of trust is generally

created by adhering to the following common factors:

 At least one trustee named should be a resident of that state jurisdiction or is a bank or trust

company that maintains an office in the state;

 The trust is irrevocable;

 The trust was not created through a fraudulent conveyance

; and

 Trust distributions to the Settlor should be under the absolute discretion of an independent trustee

(i.e., not mandatory).

Estate Tax Savings Possibilities

More Than Just Asset Protection

While self-settled trusts are designed primarily with asset protection in mind, there is an interesting

interrelationship between the debtor-creditor laws and the transfer taxes so as to make this structure even

more appealing beyond creditor protection reasons. Specifically, through settlement of an asset protection

trust there arises a unique opportunity allowing the Settlor to potentially minimize his or her ultimate transfer

tax liability.

On the one hand, an individual may wish to use his or her current $5 million lifetime gift tax exemption

amount before it expires at the end of 2012.

On the other hand, such individual might be reluctant to make

a substantial gift because of the need to maintain his or her lifestyle and feel financially secure. This dilemma

is likely more emphatic for those individuals with estates of $10 million or below due to the ongoing

Currently 13 states recognize self-settled trusts: New Hampshire; Rhode Island; Delaware; Tennessee; Missouri; Oklahoma; South

Dakota; Colorado; Wyoming; Utah; Nevada; Alaska; and Hawaii.

A fraudulent conveyance is found where the trust was formed with the intent to hinder, delay or defraud known creditors.

In certain jurisdictions, the Settlor may act as a trustee for investment and management purposes without subjecting the trust assets to

his or her creditors, so long as the Settlor has no authority to make any decisions with respect to trust distributions. While it is preferred

and recommended that the Settlor not act as a trustee in any capacity to minimize potential risks, a Settlor wishing to act as trustee to

manage trust assets should also designate an independent trustee with sole discretion over the trust distributions.

The law allows each individual to pass assets to his or her heirs free from any estate tax in the amount of the “applicable exclusion

amount” (currently $5 million per individual, scheduled to revert to $1 million beginning in 2013, without further action from Congress).

For tax years 2011 and 2012, all $5 million may be used during life.

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uncertainty initially brought about by the Economic Growth and Tax Relief Reconciliation Act of 2001

(EGTRRA) and further sustained by Congress through the Tax Relief, Unemployment Insurance

Reauthorization and Job Creation Act of 2010 (TRA 2010). However, these competing objectives do not have

to be mutually exclusive and both may be accomplished through the self-settled trust.

Legal Rationale Supporting the Dual Benefits

The ability to transfer property to an irrevocable trust, retain a discretionary interest in that trust but have the

transfer constitute a completed gift for gift tax purposes—and therefore excluded from the donor’s gross estate

at death—is a powerful estate planning tool.

The crux of the potential transfer tax benefit provided by the self-settled trust lies in the legal notion that if

property irrevocably transferred by the Settlor remains subject to his or her creditors under the laws of the

jurisdiction that governs the trust, then such property will be subject to estate tax because a Settlor whose

creditors could be satisfied with trust assets, in essence, continues to enjoy the economic benefit of the

property transferred.

Conversely, where such property

is not

subject to the claims of the Settlor’s creditors—

as in those jurisdictions recognizing self-settled trusts—then the property transferred to the trust will -not be

includible in his or her gross estate. Simply put, by achieving one benefit (asset protection) the Settlor may

simultaneously achieve the other (use of tax exemption).

Self-Settled Trust Example

Client has an $8 million estate, no judgments pending against him, and no foreseeable creditors. He would

like to use all of his $5 million lifetime gift tax (and his GST tax) exemption before the end of 2012 but does

not want to make an outright gift and worries he may need the funds to cover his living expenses in the

future. Client establishes a self-settled spendthrift trust pursuant to Nevada law (“Trust”) and transfers $5

million to the Trust. Client designates himself, his children, and grandchildren as part of a class of

discretionary beneficiaries who may receive distributions from the Trust as the independent trustee (“Trustee”)

may determine in the Trustee’s absolute discretion. Client designates Nevada Bank as Trustee; the Trust is

irrevocable; and Client cannot change any beneficial interest in the Trust.

 The Trust qualifies as a self-settled Trust because Client establishes it in Nevada (a jurisdiction which

recognizes self-settled trusts).

 The Trust is shielded from Client’s creditors because (1) the Trust is irrevocable; (2) Client has

retained no power or authority over distributions; (3) any distributions from the Trust to Client are

purely discretionary, not mandatory; and (4) Client has no power to change the beneficial interests in

the Trust.

 Client may use all of his $5 million gift tax (and GST tax) exemption upon funding because the

transfer is complete for gift tax purposes (for the same reasons stated above).

 During Client’s lifetime, Client may receive Trust distributions, but at Client’s death, the entire $5

million (plus all appreciation between the date of the gift and the date of death) will not be included

in Client’s gross estate.

The value of the gross estate includes the value of all property of which the decedent has made a transfer under which he has retained

for his life the possession or enjoyment of, or the right to income from, the property. See IRC §2036(a)(1).

It is important to note that self-settled trusts are not iron-clad asset protection arrangements, but they are useful for assets located in

the jurisdiction in which they are created and likely in other jurisdictions permitting such trusts.

A power to remove and replace the Trustee may be retained without sacrificing the asset protection benefits so long as the Settlor

cannot designate himself, or a person who is related to or subordinate to the Settlor (as defined under IRC §672). To avoid any risk

altogether, it may be advisable to designate a trust protector who is instead given the power to remove and replace the Trustee.

Note that each state has distinct laws regarding the statute of limitations period for when creditors may still reach trust assets after the

trust is initially established; and what creditors are exempt (e.g., divorcing spouses, tort claims). Nevada currently has the shortest

waiting period (generally, 2 years from the initial transfer) and allows for tacking if the situs of a trust is changed to Nevada from another

jurisdiction (i.e., the clock will not reset).

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Conclusion

While the primary reason for self-settled trusts is generally asset protection from a Settlor’s creditors, the

transfer tax benefits that may also be achieved makes this structure even more attractive where Congress has

provided a rare opportunity under TRA 2010 for an individual to make substantially large gifts during life

without the imposition of a gift tax (up to $5 million until the end of 2012). Utilizing the self-settled trust

should allow an individual to potentially obtain significant estate tax savings today while easing any concerns

that the property gifted might one day be needed to maintain his or her lifestyle.

Notes and Disclosures

The information provided is for educational purposes only and is not intended to be, and should not be construed as investment, legal or

tax advice. The information is subject to change and, although based upon information that Convergent Wealth Advisors considers

reliable, is not guaranteed as to its accuracy or completeness. Convergent Wealth Advisors makes no warranties with regard to the

information or results obtained by its use and disclaims any liability arising out of your use of, or reliance on, the information.

In accordance with Treasury Regulations Circular 230, any tax discussions contained in this communication was not intended or written to be used,

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