Asset Protection Benefits of Continuing Trusts

There are many reasons why it is important to?be?cautious when counseling clients who want to balance beneficiary control with creditor protection. For example, a grantor may distribute property to a beneficiary outright or in a trust. However, while outright distributions give the beneficiary complete control over the distributed?property,?it does not offer the asset protection benefits of a continuing trust.?The extent of a?trust’s protection is mainly dependent on the beneficiary’s right to serve as a trustee, remove and replace a trustee, and make distributions.?

Additionally, when a beneficiary serves as a trustee of their trust, their beneficial interest may be obtained by a creditor, even if the trust includes a spendthrift provision?limiting the ability of assets to be reached by the beneficiary or their creditors.?The protection offered by a beneficiary-controlled trust, that is limited by?health, education, maintenance, or support(“HEMS”), is dependent on state law. This can allow certain creditors to get to trust assets, as creditors can reach mandatory distributions and property subject to a beneficiary’s withdrawal right.?A way to combat this would be to make?it?the beneficiary-trustee’s discretion to make distributions limited?by an ascertainable standard,?such as HEMS,?thus making it so that a creditor may only reach the beneficial interest?to the extent that it would be subject to the creditor’s claim if the beneficiary were not a trustee.?

Similarly, a wholly discretionary trust will protect assets from creditors if an independent trustee is required. An independent trustee is anyone who is not an interested trustee.?An interested trustee is?related or subordinate to a transferor or beneficiary; can be removed and replaced by a transferor or beneficiary; and can be removed or replaced by a transferor with either the transferor or a party who is related or subordinate to the transferor. Finally, an interested party can be removed or replaced by a beneficiary with either?the?beneficiary or a party who is related or subordinate to the beneficiary.

Unlike an independent trustee, a beneficiary?who has the right to?serve?as sole trustee of their trust has the unfettered right to remove and replace the then-serving trustee of that trust.?Thus, making is so that?the trustee cannot be independent.?For more protection, drafters can allow a beneficiary to serve as co-trustee, combining the beneficiary’s right to remove and replace with a requirement that the removed trustee be replaced with an individual or corporate fiduciary that is not related or subordinate to the beneficiary under I.R.C Section 627(c),?or that a court or trust?protector?may?remove and replace trustees.?

Furthermore, if a beneficiary and an independent party serve as co-trustees,?a?drafter can apply a bifurcated?distribution?standard. This?allows?the independent trustee to make distributions?for any purpose,?while?the beneficiary-trustee?can?make distributions for either HEMS purposes only or not at all.?This effectively?limits?the beneficiary-trustee’s authority to make administrative and investment decisions.

The protection of trust assets will be impacted by a beneficiary’s right to serve as, remove, and appoint a trustee and withdraw and distribute assets. Consequently, when counseling clients these facts should be kept in mind.?

For more information on?asset protection of continuing trusts,?please contact the qualified attorneys at Rock, Fusco & Connelly, LLC.?