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Are my assets protected? This is one of the most frequently asked questions by trust clients. Like many such
questions, the answer is: It depends. A responsive question is: Protected from whom? This is usually
followed by: Under what circumstances? And, of course, one has to ask: Whose trust is it and what does the
trust say? Let’s look at each of these questions and attempt to shed some light on this complicated subject.
Protected From Whom? Generally, clients are concerned about protecting assets from one or more of the
following:
1) Creditors
2) Spouses
3) Other family members, often step-children
4) State or Federal Government
Creditors. Generally, creditors cannot reach property in a trust set up by a third party that is irrevocable.
However, a Revocable or Living Trust is not immune from creditor’s claims under Michigan law. This is true
for claims that arise before the death of the Grantor of the Trust.
Can creditors of one spouse reach property in a joint husband/wife Revocable Trust? There is not a clear
answer to this question under Michigan law. In Michigan, jointly held property such as real estate, stocks and
bonds, are exempt from the claims of creditors of one spouse. Whether these exemptions carry over to
brokerage accounts or Revocable Living Trusts has not been tested. Certainly, a joint husband/wife trust
creates an obstacle between a creditor and the property that would not exist if the debtor spouse owned the
property individually. So there may be some psychological protection.
If there is a showdown, in a bankruptcy court, for example, it is hard to tell how the Michigan Courts will come
out. Therefore, in the case of a young professional who is exposed to liability (such as a doctor or architect)
we advise against using Revocable Trusts and keeping property in the name of husband and wife. Similarly,
if both spouses have individual property or a significant amount of jointly held property in the form of
brokerage accounts, we may advise splitting the property between a husband trust and a wife trust, to
insulate at least a portion of the property.
Spouses. Clients often ask about the exposure of a person’s property to claims of the individual’s spouse in
the event of a divorce. If a husband and wife are both trustees of a Joint Revocable Trust, it is probable that
the property of the Joint Trust would be divided in the event of a divorce. If, however, an individual is a
beneficiary of a Trust, the individual spouse would not automatically have a claim against the Trust property in
most cases. However, if the individual beneficiary had various powers over the property, or was acting as a
Trustee, the terms of the Trust would critical. In a recent case, a divorce court decided that the husband had
enough control over the property as Trustee/Beneficiary that it was proper to take the property into account
when deciding how to divide the rest of the couple’s assets in a divorce settlement. That, of course, is a
separate question from the question whether a divorcing wife can access the husband’s trust property
directly, or vice versa.
One of the reasons we advise trusts for children is that the trust insulates the property from being blended or
merged with the couple’s other property and will generally go a long way to protecting it from claims of the
beneficiary’s spouse in the event of a divorce. Unfortunately, when one member of a young couple inherits
property, the pressure and temptation is great on the part of the inheriting spouse to contribute the inheritance
toward the joint activities, personal or business, with the result that the inheritance winds up being part of the
property divided at a divorce.
Family Members. What about claims of step-children where the step-parent is both a beneficiary and trustee
of a trust? With the number of second marriages on the rise, this will be frequent question in the future. Here
again, the answer will depend upon the exact terms of the trust, and all the other facts and circumstances.
Suffice to say that this is a family situation that is rife with potential disputes.
The Government. State or Federal claims against trust property can come from the IRS, for tax liens, or from a
State agency for benefits provided. First of all, to dispel some misconceptions, a Revocable Trust does not
protect property in any way from being deemed a countable asset for Medicaid eligibility purposes. Revocable
Trusts might play a part in Medicaid planning, but that is a separate issue. Even assets in an Irrevocable
Trust can be deemed countable assets for Medicaid eligibility, especially if the Grantor of the Trust is also the
beneficiary, as might be the case where the Trust is established with the proceeds of a legal settlement
obtained by an incapacitated beneficiary/grantor.
When the Internal Revenue Service goes after property, Courts sometimes bend Trust provisions where there
is apparent abuse, acknowledging the paramount interest of the Federal Government in collecting taxes. The
U.S. Supreme Court has recently decided that the IRS can reach jointly held property for the taxes of only one
spouse, overriding Michigan Law.
In Michigan we have some good case law supporting spendthrift provisions in trusts established by third
parties, and therefore, a well drafted "special needs" trust with spendthrift provisions is a good vehicle to
insulate property from government claims of all kinds. (The "Spendthrift" provisions of a Trust prevent transfer
of the beneficiary’s interest or trust property from being susceptible to claims of a beneficiary’s creditors.)
Trust Provisions. The key issue usually boils down to the trust provisions. What is the exact wording of the
trust concerning powers of a trustee, the amount of discretion authorized, and powers of a beneficiary to
withdraw property? How broad or how narrow is the spendthrift provision?
There are often fine lines in trust terminology that make a decisive difference where claims are made against
trust beneficiaries and/or trust property. One superfluous word can make the difference between creditor
access to trust property or asset protection., as a couple of recent cases have indicated. In one case, the
creditors of a surviving spouse were able to reach the trust property, where the spouse was primary
beneficiary and sole trustee because of the loose language of the document.
In another case, Trustee discretion over distributions was fatal where the disinterested Trustee did not in fact
participate in any trustee management or decisions. The bottom line is that there is basic conflict between
asset protection and client (or spousal) desires to have unfettered access to trust property. Words such as
"desirable" "comfort" and "happiness" can be fatal, in a legal sense, despite their warm, fuzzy connotations.
Bottom line. The bottom line is that there is probably not any particular trust language that is suitable for every
purpose, in every circumstance. However, there are circumstances where the warning flags are flying. These
can be second marriages (in almost every case). special needs family members, improvident family
members or family members in occupations with high exposure. In any of these cases, it is only prudent to be
very careful in trust drafting and not just take boiler plate language off the shelf or out of the computer without
careful analysis.
Asset protection is almost a whole specialty in itself. Sometimes the circumstances for asset protection
cannot be foreseen ahead of time. However, there are instances in family situations, as outlined above,
where the warning flags are flying and a trust draftsman should be especially careful, not only in drafting, but
to explain to clients in advance exactly what the trust terminology is designed to accomplish. Clients need to
understand that there are trade-offs where trusts are concerned. A person cannot have unrestricted access to
trust monies, as a beneficiary or trustee, without sacrificing protection for the assets from claims of creditors,
spouses, other family members, or government agencies.
©BRANDT, FISHER, ALWARD & ROY, P.C.
This newsletter is provided for informational purposes and should not be acted upon without professional
advice.
| WEALTH CONSERVATION: PROFESSIONAL ALERT Brandt, Fisher, Alward & Roy, P.C. |
| May 2002 TRUSTS AND ASSET PROTECTION by James R. Modrall III, J.D., C.P.A. |
| If you would like to receive future editions of the monthly Wealth Conservation Newsletter directly to your e-mail account, please e-mail our office using the following link: Estate Planning Newsletter |
| Brandt, Fisher, Alward & Roy, P.C. Attorneys at Law |