Trusts and the Rights of Creditors

Can a Trust Be Used to Defeat Creditors?

Using Trusts in New Jersey to Defeat Claims of Creditors

Keep Your Money from Creditors, Predators, and the Son or Daughter-in-Law You Can’t Stand (a/k/a “dislike”)

A Trust Protects Your Loved Ones Long After You’re Gone

You’ve worked hard all your life.  If you’re like me, you’d be outraged from the grave if someone else stole and/or squandered a lifetime of your savings and income.  But if you don’t set up the correct type of estate plan with a trust, that is exactly what can happen.

Take a look at what documents you have in place, if any, upon death.  Are assets being distributed to your beneficiaries outright or in trust?

If your estate is to be distributed to a beneficiary outright, the beneficiary can do whatever he or she wants with these funds. So can others. Your estate and your assets are at risk from the beneficiary’s creditors, ex-spouse in a divorce, and poor judgment.

Using a Trust to Defeat Creditors and Predators

Understanding How a Trust Can and Cannot Defeat a Creditor

Creditors are everywhere. People get into debt and can’t or won’t pay. Some creditors are flexible, others are not.  Some debtors are well-meaning but become unintentional debtors, and then there are the low-life dirt-bags who knowingly incur debts and obligations they can’t pay.

So what happens when the debtor I just described is also the creator of a trust (settlor) or a beneficiary of either a revocable or irrevocable trust?  Can a creditor pierce the trust to satisfy the debt? Can the debtor hide beyond the reach of the creditor(s) because of the trust?  The answer is…it depends, so let me explain my answer.

Trusts and Creditor’s Rights

Whether or not the terms of a trust contain a “creditor protection provision”, the following rules apply:

AS TO THE CREATOR OF A TRUST

  • During the lifetime of the settlor (a settlor is the creator of the trust and who funds the trust), the property of a revocable trust is subject to claims of the settlor’s creditors.
  • With respect to an irrevocable trust, a creditor or assignee of the settlor may reach the maximum amount that can be distributed to or for the settlor’s benefit. If a trust has more than one settlor, the amount the creditor or assignee may reach cannot exceed the settlor’s interest in that portion of the trust attributable to the settlor’s contribution.
  • After the death of a settlor, and subject to the settlor’s right to direct the source of his estate from which debts will be paid, the property of a revocable trust is subject to claims of the settlor’s creditors, the costs of administration of the settlor’s estate, the expenses of the settlor’s funeral and the disposal of his/her remains.  To the extent the settlor’s probate estate is inadequate to satisfy those claims, costs, expenses, the estate is deemed insolvent.
  • No matter if there is a creditor protection provision or not, a revocable trust under the UTC (New Jersey Uniform Trust Code) is subject to the claims of creditors “during the lifetime of the settlor”.  N.J.S.A.§3B:31-39. Creditors can go after the trust corpus.  If the probate estate is insufficient, the revocable trust is obligated to cover the “costs of administering the settlor’s estate, the expenses of the settlor’s funeral, the disposal of the settlor’s body, and to a surviving spouse and children.” As I pointed out earlier, a settlor is broadly defined as “a person who creates or contributes property to a trust.” N.J.S.A. §3B:31-3. So, this definition includes a grandparent, even if the trust he or she sets up is for the benefit of a child or grandchild.

WHAT ABOUT THE BENEFICIARY RIGHTS OF A TRUST

A Beneficiary Can Be Protected From a Creditor

According to the Uniform Trust Code (UTC – adopted by New Jersey in 2016), the general rule of thumb is that “to the extent a beneficiary’s interest is not protected by a spendthrift provision (see below for an explanation of a spendthrift provision) found within a trust, a creditor or assignee of a beneficiary can reach the beneficiary’s interest in the trust by seizing all present and future distributions made to or for the benefit of the beneficiary”.

The takeaway from this statute is the importance of a spendthrift clause in a trust.  The spendthrift statute in New Jersey says a spendthrift clause will block both the voluntary and involuntary transfer of a beneficiary’s interest in a trust.” N.J.S.A. §3B:31-36. A spendthrift provision is also “valid even if a beneficiary is named as the sole trustee or as a co-trustee of the trust.”  With a spendthrift clause, creditors of a beneficiary normally cannot seize the principal or income of the beneficiary before its receipt by the beneficiary.  Creditors also cannot force “a distribution of trust income or principal to a beneficiary” even if: (1) A trustee has discretion to make distributions for the health, maintenance, and support of the beneficiary; or (2) The trustee abuses his or her discretion under N.J.S.A. 3B:31-38 and refuses to make distributions to the beneficiary.

Creditors of a beneficiary can execute against a trust distribution when and only when the “distribution of income or principal is required be made to a beneficiary under the terms of the trust, including a distribution upon termination of the trust”, especially if the disbursement is not made within a reasonable time after the mandated date”.  N.J.S.A. 3B:31-40.

With a spendthrift clause a creditor with a claim against the beneficiary, cannot force the distribution of trust corpus or income to a beneficiary even if the trustee is permitted to make payments directly to the beneficiary. If the creditor has a claim against the trust’s creator (the settlor), and the trust is revocable, then it doesn’t matter what the trustee is doing with the property, it is still subject to the creditor’s claims.

If you are a creditor or debtor of a trust beneficiary looking for payment, you really should meet with me. I’ll explain NJ trust law and evaluate with you the likelihood of protecting or seizing the corpus ($$$) existing within the trust to satisfy debts and other obligations.

So… is it possible to…

It is possible to create a trust that gives the Trustee (who may also be a beneficiary) great flexibility in distributing the assets to the beneficiaries, and at the same time protects those assets from a beneficiary’s immaturity, misuse, creditors, divorce, etc. Also, trusts may be used when you want to direct how assets will pass upon the beneficiary’s death. For instance, many times in a second marriage a trust will be established for the benefit of the spouse but provide that upon the spouse’s death the assets will pass back to the decedent’s children. Otherwise, without a trust, your second spouse will be able to completely disinherit your children after you die. I’ve seen this happen countless times.

Come speak to me (Fredrick P. Niemann) about the benefits and drawbacks of using a trust to distribute your assets to your beneficiaries.

It may also be a good idea if you currently have a trust in place to review it to determine if its terms are still appropriate.

Some Final Thoughts About Protective Trusts

As I stated many times on this site many people establish trusts for young beneficiaries. You should look at the ages when the assets you own will be distributed outright to your beneficiaries, keeping in mind that assets distributed to somebody who is age 18 years is likely to be spent differently than if distributed to a person who is 30 years or older. It may be appropriate to increase or lower the age(s) at which a beneficiary will receive an outright distribution from your trust.

Alternatively, it may be appropriate to give the beneficiary an income stream or give the Trustee greater discretion to make distributions from the principal as circumstances warrant. For example, a trust might say that a child will receive the income from the trust starting at age 25, and that the principal must be distributed to the child outright at age 30 and 35. Prior to age 35, the trust principal can be used for the beneficiary pursuant to the terms of the trust or at the discretion of the trustees. By structuring a trust this way, the beneficiary has an opportunity to learn how to manage money.

Don’t overlook beneficiaries who have or may in the future have special needs and/or require public benefits

If you have a beneficiary who is elderly (a parent, in-law, great aunt, etc.) or disabled, that beneficiary may need to qualify for public benefits in order to maintain their standard of living. If a person who is receiving public benefits receives an inheritance directly, the public benefits will cease, and the person must exhaust the inheritance to pay for the care that public benefits would otherwise have provided for. Once the inheritance is exhausted, the person must then reapply for benefits. This can be a traumatic and expensive process. Instead, you should consider leaving assets in a purely discretionary Special Needs Trust for the person, drafted in such a way that it does not interfere with the person’s ability to receive public benefits. By using this approach, the trust becomes a security blanket for the beneficiary, not a burden.  If you would like to learn about special needs trusts in New Jersey that can benefit a disabled person, I invite you to visit my dedicated Special Needs Trust page by clicking here.

Fredrick P. Niemann Esq.

Not sure if your trust will protect beneficiaries or your estate from creditors and others?  If you have any questions,

Contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at fniemann@hnlawfirm.com.  He welcomes your calls and you’ll find him to be easy to talk to and very approachable.

 

 

 

Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a New Jersey Trust Attorney

Trust attorney serving these New Jersey Counties:

Monmouth County, Ocean County, Essex County, Cape May County, Mercer County, Middlesex County,
Bergen County, Morris County, Burlington County, Union County, Somerset County, Hudson County, Passaic County