The world of asset protection trusts has been scrutinized due primarily to the design whereby a person who could someday become a debtor (to someone) can be insulated from paying his/her debts. A common strategy to accomplish this is for a person (i.e., the trustmaker) to create a self-settled asset protection trust (meaning a trust in which the trustmaker names himself or herself as a beneficiary) in advance of any debt, creditor or litigation.

Resistance by Creditors. Creditors challenge such trusts as being unfair because a trustmaker could still have access to the trust assets as a beneficiary while the creditor cannot access those trust assets. The fact that the trustmaker is a beneficiary of the trust invites scrutiny regarding the effectiveness of such trusts. This has led some advisors to suggest that the trusts be created only for a beneficial class that does not include the trustmaker, as doing so can better insulate the trust assets from creditors of both (i) the trustmaker, and (ii) the beneficiaries. A trustmaker, however, may not be keen on the idea of creating such “third-party trusts” if the trustmaker wants to be eligible to receive assets back from the trust.

Best of Both Worlds? Just suppose, however, that the trustmaker can create a third-party trust (i.e., a trust that does not name the trustmaker as a beneficiary) but still be eligible to receive benefits from the trust someday. This is much more possible today now that many states having adopted statutes allowing third party trusts: (1) to reimburse a settlor for personal income tax obligations that arise from trust income; (2) to be decanted to other trusts; (3) to be modified, restructured or reformed; (4) to grant powers of appointment to other persons, which can result in the trustmaker becoming in essence a beneficiary at any point; (5) to be revised through non-judicial settlement agreements; and (6) to appoint non-fiduciary protectors who can adapt a trust to changing circumstances. This statutory flexibility however paves the way to allow courts to view such a trust as equivalent to a self-settled trust and therefore more prone to attack.

Still Possibly the Better Option. Nevertheless, these statutory developments can be applied to reconfigure a trust to such an extent that the flexible third party trust may still be more attractive to an individual who likes the enhanced protection and yet could regain access to the assets placed in to the trust. If the state law fails to provide the needed flexibility, then (so long has the trust provisions allow for a change in the governing law of the trust and do not preclude certain changes) the trust situs could be changed to a state that does allow the needed flexibility. Such flexibility, however, has the corresponding downside (for the reason stated above) that the trust assets may not be as protected as first thought. More specifically, a judge or jury could perceive the potential boomerang impact these statutes could have as being tantamount to a third party trust that is convertible to a self-settled trust. It is not helpful that there is already a good bit of marketing literature and public seminars that express this conversion feature as a strategy to avoid the flaws of a self-settled trust. The growing literature in this realm is suggesting that such third party trusts are conveniently convertible to a self-settled trust whenever desired/needed.

Third party trusts that can be revamped to such a large degree under modern trust law to provide many similar qualities as the self-expressed self-settled trust may still nevertheless allow such third party trusts to be a superior design to the trusts that explicitly state that the settlor is a beneficiary of the trust, at least for the short term. As these distinctions begin to fade, however, and as these similarities between the two trust styles become more commonly known, the added protection by third party trusts may begin to erode.

The Ultimate Protection. In anticipation of this, the wisdom of using offshore trusts (as opposed to domestic trusts) that are funded with a nest egg that is physically located offshore, coupled with a true relinquishment of unilateral control by the settlor over access to those trust assets, may be the recommended design if a higher level of protection is desired. Giving up unilateral control does not mean the trustmaker cannot entrust carefully selected individuals or professionals with powers to be able to carry out actions that the trustmaker would find to be in harmony with his or her liking. Such individuals and professionals must at the same time be likely to act only under their own independent judgment as they deem to be fitting for any given change in circumstance occurring after the trust is formed (as opposed to being influenced in any way by the trustmaker).

Even though such offshore trusts can be excellent vehicles, in that an offshore trustee cannot be directed by a US court to disband trust assets due to a finding of any perceived ulterior motive embedded in a trust design, equally important is the choice of an offshore trustee who is of the highest integrity who can confidently be trusted to act in the best interest of the beneficiaries and to carry out the originally intended goals of the trustmaker. This better ensures that the nest egg will be used only as intended, and not end up in the hands of those who may harbor ill-will toward the trustmaker or the trustmaker’s family.