In a recent interview I did with CBS, I revealed why self-settled trusts leave wealth exposed to lawsuits and bankruptcy.
Using self-settled trusts as a way to protect assets has skyrocketed in popularity in recent years. However, there are several pitfalls in using self-settled trusts in the place of robust, traditional asset protection plans.
In a self-settled trust the grantor and beneficiary are the same, unlike in conventional trusts.
The reason why self-settled trusts are appealing to many is because the grantor/beneficiary has access and can enjoy the trust’s assets but cannot legally transfer the title or proceeds to debtors. Or at least, that’s the theory.
One common type of self-settled trusts is domestic asset protection trusts. However these types of trusts are not recognized in every state.
The law on domestic asset protection trusts varies by state. In a state that does not recognize domestic asset protection trusts, a grantor/beneficiary who transfers a large portion of his or her assets into the trust is not protected from creditors.
It’s also difficult to ensure asset protection even in states with laws friendly to domestic asset protection trusts, particularly when it comes to bankruptcy.
There is court precedent of creditors filing an involuntary bankruptcy petition even in states that recognize domestic asset protection trusts, which would then expose the assets in your trusts and put you in a vulnerable position.
Contrary to popular belief, the other type of self-settled trust – the foreign asset protection trust – cannot shield assets either.
The main idea behind foreign asset protection trusts is that US Courts hold no legal power over trusts in foreign countries. However, the courts can and often will order someone in debt to repatriate their funds and assets from overseas.
I added that those who don’t follow the court’s orders can face jail time.
Let’s say you owe taxes to the IRS, for instance, and it’s proven that you have assets in a foreign trust, then you can be penalized for not moving the assets back into the country in order to pay your tax liability.
When creating a thorough plan to protect your assets, the best thing to do is to avoid self-settled trusts. This is because non-self-settled trusts have the backing of state and federal law, as well as federal bankruptcy code, which are there to provide you with an additional layer of protection.