To understand self-settled spendthrift trusts, you first need to know what a spendthrift trust is in general. Spendthrift trusts are trusts basically created for the purpose of controlling how a beneficiary uses the funds. These are made when the trust creator predicts that the beneficiary will not be able to manage the funds.
For example, say you wanted to create a trust for your grandchild but feared they would spend it all on partying. In this case, a spendthrift trust would be an ideal setup so you could decide when to distribute funds and control the amount.
A trustee will be appointed to oversee how the funds are distributed to the beneficiary, which will be according to the trust creator’s intention that is set out in the trust. In the scenario above, the independent trustee would have the discretion to determine what would benefit the beneficiary, which is usually laid out in the trust. For instance, it could say that the distributions could be used for education or investments. Thus, the beneficiary will not have a say in how to spend the money and cannot take any from the general funds.
A clause in the trust will need to explicitly designate it as being a spendthrift trust. If there is not a spendthrift clause, the courts will not treat it like one. This becomes important if any issues arise under enforcement of the trust.
A spendthrift trust is considered to be “self-settled” when the trust creator and beneficiary are the same person. There also can be no other beneficiaries of the trust. However, there is still a trustee involved that manages and distributes the funds. Other names for these include self-designated trusts or Alaska trusts.
Why are Self-Settled Spendthrift Trusts Appealing?
Self-settled spendthrift trusts gained popularity because creditors are restricted from what they can collect under a typical spendthrift trust. Creditors cannot take money from the general funds of a spendthrift trust. They can only collect from the distributed funds. This led to a surge of people setting up self-settled spendthrift trusts in an attempt to avoid creditors seeking to collect on their debts.
Because of this, self-settled spendthrift trusts are highly regulated. In fact, most states do not allow these types of trusts. Many states have laws that state that if the trust creator and beneficiary are the same person, they will not be protected from creditors like spendthrift trust funds normally are.
However, even though there is the potential for abuse of these trusts, some states allow them. This is because they can help protect personal assets (when necessary and not abusive) and can make estate planning easier to navigate.
Which States Allow Self-Settled Spendthrift Trusts?
Alaska was the first state to allow self-settled spendthrift trusts, which is why they are sometimes referred to as Alaska trusts. However, under Alaska law there is a four-year period after the trust is created before the trust funds receive protection from creditors.
Nevada also allows self-settled spendthrift trusts, but has more liberal regulations. Under Nevada law, there is only a two period after the trust is created before the trust funds receive protection from creditors. Also, Nevada law allows the person who created the trust to be boeth the beneficiary and trustee. If this is the case, there will be more restrictions on how the funds can be disbursed.
A number of other states besides these two also have laws that address “Domestic Asset Protection Trusts” (a.k.a DAPT statutes). This allows for self-settled spendthrift trusts with the goal of creditors not being able to get to the money in the trust. This needs to be created domestically, as an offshore international account would not qualify.
Under a DAPT statute, the trustee has discretion over distributions and the beneficiary’s interest cannot be assigned. All of this is meant to protect the person’s assets but abuse of this function is still prohibited.
In addition to Nevada and Alaska, the following states have DAPT statutes: Delaware, Hawaii, Michigan, Mississippi, Missouri, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming. If your state is not on this list, then you cannot set up this type of trust as an attempt to protect your assets.
Do I Need to Hire a Lawyer to Help Create a Self-Settled Spendthrift Trust?
If your state has a DAPT statute that allows for self-settled spendthrift trusts, then you should contact a local estate planning lawyer to help you create the trust. A lawyer can research your state’s laws and make sure you meet all the requirements, which will be strict. This will help you avoid any allegations of fraud that creditors may try to make. A lawyer can also draft the trust in a way to make sure that your assets are protected while still complying with the law.