Spendthrift versus Grantor Trusts

Asset protection trusts come in at least two varieties: Grantor trusts and spendthrift trusts.

A grantor trust is a trust established by a person (the “settlor” or “grantor”) for the benefit of the settlor.  An example of a grantor trust would be Bugs Bunny setting up a trust and naming himself as the beneficiary.  A spendthrift trust, on the other hand, is a trust established by a settlor for the benefit of a third-party.  Spendthrift trusts prevent beneficiaries from assigning their interest (voluntarily or involuntarily) in the trust to any other party, including creditors.

Traditional Asset Protection

Traditionally, grantor trusts did not provide much in the way of asset protection.  That’s because courts refused to uphold spendthrift provisions–the provisions that bar creditors from obtaining trust assets–contained in such trusts.  It would just have been too easy for people to name themselves as beneficiaries of a trust and keep trust assets away from creditors.

Courts have, however, traditionally upheld spendthrift provisions where the trust settlor and beneficiary (or beneficiaries) are different people.  In that case, the appearance of impropriety is avoided, and it seems much less likely that trusts are created just so the settlor can maintain control of assets while placing them beyond the reach of creditors.  The spendthrift trust, therefore, was the original tool used by asset protection attorneys.

To some extent (and in some states), assets within spendthrift trusts are protected even if the beneficiary also serves as the trustee.  There is some asset protection case law in Florida, for example, where the court decided that trust assets were protected even though the trust creator named the same person as beneficiary and trustee.

New Status for Grantor Trusts

In the 1980’s, the Cook Islands enacted a statute that protected assets held in grantor trusts.  In other words, the statute provided asset protection by enforcing spendthrift provisions in grantor trusts.  Grantor trusts with enforceable spendthrift provisions are widely referred to as asset protection trusts.  This new class of asset protection trust provides the highest form of protection while allowing individuals to maintain control over their assets.

Many people ask whether these types offshore trusts are legal.  The answer to that question is a resounding YES!  In fact, at last count more than ten U.S. states have enacted statutes providing protection for grantor trusts containing spendthrift provisions.  That fact alone shows that there is broad support behind the essential tools of asset protection.

There are two problems inherent in relying solely on domestic asset protection trusts.  First, they are untested.  There are very few cases interpreting the domestic asset protection trust statutes.  Second, they leave your assets exposed to judges in this country.  Any time your assets are within the jurisdiction of a domestic judge, you are at risk.