TROUBLE IN ILLINOIS
The Illinois Supreme Court recently ruled, however, that a self-settled trust wouldn't be respected.
In the case, Rush University Medical Center vs. Sessions, a man named Sessions established a family limited partnership in Colorado. Later, in 1994, he established the Sessions Family Trust in the Cook Islands, in the South Pacific. The trust was a foreign asset protection trust.
Most advisors believe this type of trust to be more secure than the domestic version since it does not face the risk of having to respect another jurisdiction's court rulings under the Full Faith and Credit Clause.
Sessions transferred 99% of the family limited partnership interests as well as some property in Hinsdale, Ill., to the foreign asset protection trust. In the fall of 1995, Sessions made a pledge of $1.5 million to the Rush University Medical Center for the construction of a new president's house on the university's campus in Chicago. Relying on his pledge, the medical center built the house and even held a public dedication honoring Sessions, who executed several codicils to his will reflecting that any portion of the pledge that was unpaid at his death should be paid from his estate.
Sessions died on April 25, 2005, and on Dec. 15, 2005, Rush filed a complaint against Sessions' estate to enforce the pledge. The third count in the complaint contended that if a settlor creates a trust for his own benefit, it is void to existing and future creditors and that those creditors can reach his interest in the trust.
The court ruled: "Traditional law is that if a settlor creates a trust for the settlor's own benefit and inserts a spendthrift clause, the clause is void as to the then-existing and future creditors, and creditors can reach the settlor's interest under the trust." And the Illinois Supreme Court held that common-law creditor rights and remedies remain in full force.
Bottom line: If you set up a trust in Illinois for yourself, your creditors can reach that trust.
While the Rush case makes it sound as if self-settled trusts won't work, remember a few key factors.
First, the issue critical to most self-settling trusts has never been tested at the Supreme Court level. In addition, these trusts have been used with growing frequency for nearly 15 years. Also, laws supporting them have been enacted in a growing number of states.
If you have a high-net-worth client who is planning to use a self-settled trust, you can take prudent steps to lessen the risks that trust assets will be included in his or her estate.
*Demonstrate that the client was solvent before and after any transfers to the self-settled trust. Show that the client retained sufficient non-trust assets to maintain his or her lifestyle and pay debts. A budget plan and investment plan demonstrating that remaining assets should provide for the client's needs with a reasonable degree of probability may be one way to corroborate this.
For example, run Monte Carlo simulations demonstrating an 80% or higher probability that the retained, non-domestic asset protection trust assets will support the client into his or her nineties.
There is no real guidance yet as to what life expectancy, or what degree of assurance, might be necessary to demonstrate sufficient retained assets. Therefore, this will be a judgment call.
* While rules of thumb can be quite misleading, some suggest that not more than one-third of a client's assets should be transferred into a self-settled trust.
* The assets transferred to the trust should be viewed as a safety net - and not as assets the client will need to access for income, cash flow or principal to live on.
* Corroborate that the creation of the trust and the transfer of assets to it was not a fraudulent transfer.
DIVORCE AND AGING
* If the client becomes a beneficiary of the self-settled trust only if he or she is no longer married to the spouse the client had when the trust was established (in other words, after the spouse has died or after a divorce), you may avoid the issue. If the client dies before the spouse, he or she will never have been a beneficiary and the trust may not be able to be classified as a self-settled trust.
* If the client is precluded from being a beneficiary for some period of years, it may similarly minimize tax risks. If the trust prohibits the client from being able to receive a benefit for 10 years and a day, for example, you might achieve additional security.