What Is A Self-Settled Trust And How Does It Support Asset Protection?

A self-settled trust permits a person to draft up a trust in which they are the sole beneficiary to their own assets. This is distinct from a typical trust, in which the assets of the grantor are conveyed for the benefit of others, such as family members or charities. An asset protection trust is any in which its assets are safe from pursuit by creditors, taxation, divorce and bankruptcy claims.

Recent discussion of the effects of the use of self-settled trusts has thrown them back into the limelight. Therefore, this article will explore their nature, such as what it hopes to achieve, its formation requirements, how it supports asset protection, and the jurisdictions in which it is available protection.

Basics of Asset Protection

Asset protection trusts are distinct from any other type of trust in that their purpose is unary: to protect its assets. They are irrevocable, and so any movement of assets is permanent; this means that the removal of assets from the trustor’s ownership removes the chance of creditors pursuing it forever.

Asset protection trusts are able to protect the assets they contain as they delineate a beneficiary’s enjoyment of the assets from their legal ownership. Thus, the trust’s beneficiaries do not have a legal title for the ownership of such assets, merely the benefit to enjoy them.

This presents a unique opportunity to protect assets in a legal manner. Creditors’ claims will be rejected as they can only pursue assets in the legal name of the beneficiaries, which is not what happens when they are merely granted the enjoyment of the assets.

How Self-Settled Trusts Help

The use of self-settled trusts for the protection of assets is increasing in popularity, especially as the viability of doing so in a domestic jurisdiction improves. Traditionally, trust law allows a grantor to transfer certain assets to a trustee, intended for the benefit of some third parties (the beneficiaries), such as various family members, for example. 

By transferring assets through a trust, ownership of the legal title to the assets is made distinct from ownership of the equitable title to them. Once in the trust, assets are largely insulated from any future claims from creditors against either the grantor, trustee or beneficiary.

Dividing Rights to Assets

This splitting of titles into legal and equitable halves is able to shield assets in the trust as creditors cannot make claims against the trustee or beneficiary as neither have a legal ability to demand distributions or convey title.

It is common for trusts to include a spendthrift clause. This provision is intended to preclude beneficiaries from being able to assign away interest in future income or the trust’s assets to creditors. This provides the added benefit of protection preventing creditors of any beneficiary to the trust from being unable to pursue income or assets from the trust.

What sets self-settled trusts apart from regular ones is that they enable the grantor to also be a beneficiary of the trust (i.e. for the grantor to keep hold of the benefit of trust assets). This occurs because the grantor only conveys the legal title to the trustee (so that such assets are beyond the reach of creditors’ claims.

Several foreign jurisdictions and over 15 US states permit this manner of organizing a trust. They are popular for asset protection trusts since they enable a grantor to enjoy the benefit of the trust’s assets alongside the protection of being unable to transfer title to a creditor. Asset protection trusts and self-settled trusts are often two of a kind, and used interchangeably.

Foremost Asset Protection Jurisdictions

Domestic Asset Protection

Following Alaska’s lead in 1997 to become the first state to permit self-settled trusts as a means of protecting assets, fifteen others have since followed. The trusts offered by these states, such as Wyoming, are referred to collectively as Domestic Asset Protection Trusts (DAPTs).

These DAPTs must meet specific requirements in order to be recognised in law. For starters, it has to be irrevocable and contain a spendthrift clause. Secondly, at least one trustee needs to be appointed who is a resident and at least a portion of the management of the trust has to occur in the respective state. Finally, the grantor cannot simultaneously be a trustee.

For those considering DAPTs for the purpose of conserving wealth, it is worth evaluating which factors will end up being scrutinized if prompted to expound why this structure is necessary in court. It is always in your best interest to employ the guidance of skilled and qualified professionals who can constructively contemplate all possible factors that might act as a roadblock.

Some of the factors which may be considered include the state in which the trust was formed, the state the grantor resides in (and are thus most likely to be sued), who the trustee is and where they live, how many beneficiaries there are, and the asset class protection is being sought for.

For the purposes of edification, liquid assets (such as cash) are viewed far more favorably for the intention to relocate to more protective jurisdictions, but the opposite is true for fixed assets (such as real estate) – which are at a far greater risk of being bound by the laws of the local state.

Global Asset Protection

It is very common for US citizens to establish an asset protection trust based in a foreign jurisdiction permitting self-settled trusts, as it would then be governed by that jurisdiction’s, rather than the US’s, laws.

This is advantageous because it renders the result of a US lawsuit against the grantor meaningless as the courts of the foreign jurisdiction (where the grantor’s trust is held) will be unlikely to rule in the creditors’ favour. As an additional benefit, asset protection trusts based in a foreign jurisdiction offer amplified privacy protections concerning the disclosure of the assets held in the trust to third parties.

Some of the global jurisdictions that are conducive for asset protection trusts include the Cayman Islands, Nevis, the Cook Islands, the Bahamas, Belize, the Channel Islands and Switzerland & Lichtenstein.

Closing Statement

Self-settled trusts are an effective way of protecting the assets in a trust that allows the grantor to concurrently act as the beneficiary of his/her own trust. Whilst it has become more common for domestic jurisdictions to offer this protection, it is worth talking to a legal professional as these trusts can be subject to intense judicial scrutiny domestically.

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