Trust Planning and its Interplay with Asset Protection – An Overview

By: Ami S. Longstreet

Asset protection planning is the development of legal planning techniques to place the client’s assets beyond the reach of future (not present or known) creditors.

Many individuals have the potential for future creditor problems, whether it be through divorce, malpractice claims, tax liens, business claims, long term care expenses or other catastrophic expenses. Therefore, it would be prudent for individuals to discuss asset protection with an attorney who specializes in this area of the law.

There are many different asset protection methods. This blog only addresses the use of trusts for asset protection.

1. SUPPLEMENTAL NEEDS TRUSTS.

A Supplemental Needs Trust (“SNT”) is established for the benefit of a disabled individual, to supplement government benefits such as Medicaid and SSI, while not affecting the individual’s eligibility for those benefits.

a. SELF SETTLED SUPPLEMENTAL NEEDS TRUSTS.

For self-settled SNTs, the individual must be disabled and under 65 years of age when creating this trust, and Medicaid has a right of recovery from the assets in the trust, if any, when the individual passes away.

Additionally, the trust must be established by a parent, grandparent, legal guardian or the Court, and the funds of the disabled individual are used to fund the trust.

Payments from the trust should not be paid directly to the disabled individual but should be used for his or her benefit and, if the individual is in receipt of SSI, should not be used for food or shelter.

b. THIRD PARTY SUPPLEMENTAL NEEDS TRUSTS.

A third party SNT is funded by someone other than the disabled beneficiary for the benefit of the disabled beneficiary. This can be created during lifetime or through a will or trust when an individual dies. When properly drafted, the third party supplemental needs trust provides benefits to the disabled individual for items not covered by Medicaid or SSI. The beneficiary does not have the right to withdraw monies from the trust and the trustee does not pay the disabled beneficiary directly.

c. POOLED TRUSTS.

Pooled Trusts are trusts created by a not-for-profit organization. Individual beneficiaries create accounts within the larger trust created by the not-for-profit organization. Very often these trusts are used to place a disabled individual’s excess income for individuals on Medicaid and that excess income can be used for the individual’s supplemental needs.

2. SOLE BENEFIT TRUSTS.

A parent may transfer assets to a lifetime trust for the sole benefit of a disabled child without incurring any period of Medicaid or SSI ineligibility for the parent. Any person (e.g., a parent) may transfer assets to a trust established for the sole benefit of a disabled individual under the age of 65 without suffering the imposition of a Medicaid penalty period for the individual creating the trust.

3. DISCLAIMER TRUSTS.

A Disclaimer Trust Agreement provides a flexible vehicle so that the surviving spouse can determine whether or to the extent to which the trust should be funded. Given today’s uncertain estate tax environment, the disclaimer trust has become a popular estate planning tool.

Does a disclaimer trust provide asset protection? As it relates to Medicaid, there is a 5 year waiting period in order to be eligible for Medicaid from the time that the disclaimer is filed. As it relates to other creditors, if at the time of the death of the first spouse, the surviving spouse were subject to claims of his or her individual creditors, or the surviving spouse was aware of potential creditors, the disclaimer could be a fraud against those creditors. Because a disclaimer must be executed within 9 months following the date of the first death, attention must be given to the timing of the disclaimer.

4. QTIP TRUSTS.

A qualified terminable interest property trust (“QTIP”) limits a surviving spouse’s access to, and control of, the property contained in the trust. A QTIP trust is eligible for the marital deduction and thus the surviving spouse is entitled to all of the income from the trust. The trust can also provide access to principal, often using an ascertainable standard.

Are the assets in a QTIP trust exempt from the creditors of the beneficiary of the QTIP trust? For Medicaid purposes, if properly drafted, the principal is protected.

As it relates to other creditors, if the creation of the trust is not voluntary on the part of the spouse beneficiary, it would seem that it would be protected against creditors.

5. CREDIT SHELTER TRUSTS.

For married couples with taxable estates, it used to be common for each spouse to create creditor shelter trusts to cover the Federal estate tax exemption. With the higher estate tax exemption, and estate tax portability, the use of this method may decrease. In any event, credit shelter trusts often allow access by the surviving spouse to the assets in the credit shelter trust with the consent of the trustee.

Are the assets in a credit shelter trust protected from the creditors of the surviving spouse? As it relates to Medicaid, the answer depends on the status of the surviving spouse’s right of election.

As it relates the other creditors, assuming there was no fraud as it relates to existing or known creditors prior to death, the assets not available to the surviving spouse should be protected against said surviving spouse’s creditors.

6. IRREVOCABLE INCOME ONLY TRUSTS.

Irrevocable Income Only Trusts are grantor trusts into which the grantor puts a sum of money and usually receives back the income earned from the assets put into the trust for the rest of his or her life. After a 5 year waiting period, the corpus of the Irrevocable Income Only Trust is not available at it relates to Medicaid. The income, in these circumstances, would be available.

What about other creditors? Again it would seem logical that, if upon the establishment of the trust if properly established, the grantor had no known creditors, the principal assets in the trust would be protected from future creditors. In general, the creditors of the settlor/beneficiary will be able to reach that amount of trust income and/or principal which the trustee, in the maximum exercise of the Trustee’s discretion in favor of the settlor beneficiary, could pay or apply for the benefit of the settlor-beneficiary under the terms of the trust.

7. DOMESTIC ASSET PROTECTION TRUSTS (DAPTs).

The Domestic Asset Protection Trust is similar to an offshore trust, and must be formed in one of several states allowing for self-settled asset protection trusts. Alaska was the first state to allow such trusts, followed by Delaware and later, Nevada. Several other states have enacted similar legislation, but significantly, New York has not adopted legislation allowing for self-settled asset protection trusts.

A self-settled asset protection trust is a trust in which the settlor has retained a beneficial interest, but which interest does not cause the assets in the trust to be subject to the creditors of the settlor.

Each state that has adopted legislation allowing DAPTs has requirements that are somewhat different, in terms of connections with each particular state, as it relates of location of assets and choice of trustee.

8. OFFSHORE TRUSTS.

An offshore trust is one in which at least one trustee is located offshore, and which trust is construed, interpreted, administered, and subject to the laws of a foreign country.

Foreign Asset Protection Trusts (FAPTs) are more protective than DAPTs for many reasons, not the least of which is the creditors’ attorney’s lack of knowledge of foreign law, as well as jurisdictional issues. Additionally, the trust laws of certain foreign jurisdictions are often more protective than domestic trust laws.

 

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