The Wealth Counselor
By Michael P. Rapps
In last week’s article, “Three Ways to Limit Your Liability,” we discussed how Mr. Manna could protect his personal and business assets from lawsuits and creditors by using insurance and statutory exemption planning, and creating a suitable business entity like a limited liability company. Today we’ll explore a more sophisticated strategy recommended by his attorney, Mr. Kruger, to safeguard Mr. Manna’s property for both him and his family.
What are asset-protection trusts? “Asset protection has become a common goal of estate planning,” Mr. Kruger tells Mr. Manna, “and my suggestion is that you establish an asset-protection trust.”
As we discussed in “Irrevocable Trusts: A Valuable Tool in Medicaid Planning” (July 15 5TJT, pages 48—50), a trust is a contract between the grantor–the person who creates the trust–the trustee, who controls the trust, and the beneficiaries. While a revocable trust permits you to maintain full control (as trustee) and have access to all your assets (as beneficiary), an irrevocable trust may prohibit your right to control the trust (as trustee) or have access to your assets.
“An asset-protection trust is a special type of irrevocable trust in which the trust funds are held and invested by the trustee and are only distributed on a discretionary basis,” the attorney elaborates. “The purpose of an asset-protection trust is to keep the trust funds safe and secure for the benefit of the beneficiaries instead of having those assets be an available resource to pay a beneficiary’s debts.”
“An irrevocable trust also protects and benefits you, the grantor,” Mr. Kruger adds. “Since you can no longer access the assets, they are sheltered from your creditors. In addition, since you no longer own the assets outright, creating this type of trust allows you to qualify for Medicaid while providing a source of income for your wife. It also prevents the assets from forming part of your estate when you die, so the government cannot access them to recover the Medicaid benefits they granted to you.”
Domestic asset-protection trust (DAPT). Mr. Manna asks his attorney, “Is it possible to protect assets in a trust and still be allowed to receive distributions directly from that same trust?”
“Do you remember the ‘Panama Papers’ scandal in April, which exposed how much wealth was being sheltered in offshore accounts?” asks Mr. Kruger.
“Sure,” replies Mr. Manna, “that was big news.”
“Well,” continues Mr. Kruger, “offshore trusts used to be popular because many jurisdictions outside the United States allowed the grantor of an asset-protection trust to be a discretionary beneficiary of that trust. However, in order to compete with these offshore jurisdictions for trust business, many states have passed legislation allowing for asset-protection trusts to include the grantor as a beneficiary.
“A domestic (rather than offshore), self-settled (as opposed to a third-party trust where the beneficiary is someone other than the grantor) asset-protection trust avoids some of the burdensome IRS reporting requirements and the very real concern that an unscrupulous offshore trust company will steal your assets out from under you. While the laws of these states vary widely, in general they require the trust to be irrevocable, that at least one trustee be a state resident or a corporation authorized to do business in the state, and that some assets be located in the state. From there, the laws differ on ‘exception creditors’ (creditors who can still access the trust assets, such as an ex-spouse who is owed alimony or a child who is owed child support) and statutes of limitation with regard to preexisting and future creditors (1.5 years to 6 years).”
Mr. Kruger continues, “There are only a limited number of U.S. cases interpreting domestic-asset-protection statutes, and this type of planning is still developing. Nonetheless, when layered with other types of asset-protection planning, including liability insurance, third-party asset-protection trusts, and limited-liability entities such as LLCs or corporations, a domestic self-settled asset-protection trust can help create additional roadblocks between your assets and your creditors.”
What are the risks of outright inheritances? “Leaving an inheritance outright to your child or grandchild without any strings attached is risky in this day and age of high divorce rates, lawsuits, and bankruptcies,” Mr. Kruger cautions.
“Aside from this, your beneficiaries may not have developed the financial skills necessary to manage their inheritance over the long run. There is also the very real risk that an outright inheritance left to your spouse will end up in the hands of a new spouse instead of in the hands of your children or grandchildren. Finally, a beneficiary may be born with a disability or develop one later in life, and end up rapidly depleting their inheritance to pay for medical and other bills.”
How do you protect your assets from those risks? “Is there a way to safeguard against all of these scenarios?” Mr. Manna asks, perturbed. “I don’t want my wife to worry about money if I die, but at the same time I don’t want my hard-earned assets to subsidize her future spouse and his children.”
“Fortunately, there are a number of different types of asset-protection trusts that you can establish to ensure that your assets are used only for the benefit of your family,” Mr. Kruger reassures him. “If you’re also worried that your wife won’t be able to manage her inheritance or will need nursing-home care, her legacy can be held in a lifetime discretionary trust. Since your children are 14 and 16, they can’t legally accept an inheritance yet, so a discretionary trust is a necessity for them too. I’m sure they’re good kids, but some of my clients have children with addiction problems, and in that case I urge them to create a trust for their benefit.”
“What if my spouse or children become disabled, like you mentioned?” Mr. Manna asks.
“Disabled beneficiaries who receive an inheritance outright run the risk of losing government benefits and would need to spend down the funds to requalify,” Mr. Kruger responds, “but an inheritance left to a special-needs trust can be used to supplement, not replace, government assistance.”
How do you compensate for loss of control? “The fact that these asset-protection trusts are irrevocable makes me nervous,” Mr. Manna admits.
“I understand that it feels like a loss of control,” Mr. Kruger responds; “however, you as grantor determine how the trusts would be operated, who benefits, how, and when. Asset-protection trusts designed for inheritance protection can be as rigid or as flexible as you choose. For example, your daughter can be added as a co-trustee at a certain age–say 25–or after she reaches a specific goal, such as graduating from college. Another option is to name a corporate trustee, such a bank or trust company, but give the beneficiary the right to remove and replace the corporate trustee with another one.
“You can also make trust distributions as limited or as broad as you choose. For example, you can state that the funds must only be used to pay for medical bills or education, or the trustee can be given broad discretion to make distributions in the best interest of the beneficiary.
“You may also want to require the trustee to take into consideration the beneficiary’s income and other assets before making distributions. If there are multiple beneficiaries, such as a trust for the benefit of your spouse and your children, the trustee can be directed to give preferential treatment to one or more beneficiaries over the others.”
Mr. Kruger explains that with Medicaid planning trusts, the rules are more flexible. You are able to change your mind at any time about your beneficiaries; choose or remove your trustee; decide whether the trust income is taxable to you or your beneficiaries; and decide whether the trustee can or cannot provide you with income from the trust.
“Business has started to pick up in the past few years,” Mr. Manna says, “but I never thought my kids would qualify as ‘trust-fund babies.’ After all, my estate isn’t that large.”
“Actually, asset-protection trusts offer many planning opportunities even for people of modest means,” Mr. Kruger informs him. “They’re a useful tool that can easily be incorporated into your estate plan.”
Mr. Manna is relieved that there is an additional way to protect his hard-earned assets and ensure that his wishes for his legacy are respected.Â v
Michael P. Rapps is the managing attorney at Rapps & Associates, PLLC, located in Woodmere. His practice focuses on estate, asset-protection, and business-succession planning. He can be reached at firstname.lastname@example.org or 516-342-3756.