Protecting Inheritances from Creditors

By Ward J. Wilsey, JD, LLM3655 Nobel Dr. Suite 345

San Diego, CA 92122(858) 764-2672

wardwilsey@wilseylaw.com

The ProblemDiscretionary Trust is probably the most

powerful asset protection device under California lawCan only be used for inheritances

This type of Trust is almost never used for inheritances

Almost all Trusts are susceptible to creditorsLawsuit PlaintiffsBankruptcy CreditorsDivorce and AlimonyGovernment Reimbursement for Benefits

Types of Trust1. Mandatory Distribution Trust2. Ascertainable Standard Trust3. Discretionary Trust

Mandatory TrustTrust must pay out a set amount or

percentage of the Trust Principal or IncomeEx.

Pay All Income to BeneficiaryPay 4% of Trust Assets per year to BeneficiaryPay $100,000 per year to BeneficiaryPay out ½ at 25 and rest at 35

Beneficiary has property right, enforceable in court to the mandatory payment each year.

Ascertainable StandardHealth, Education, Maintenance, and SupportOriginally used for estate tax purposes, to keep

assets out of Trustee/Beneficiary’s EstateBypass Trust is an exampleDefined in Treasury Regulation 20.2041-1(c)(2)

Now it seems most common type of TrustBeneficiary has a property right, enforceable in

court, to distributions for Health, Education, Maintenance, and Support

Effect of a Property RightIf the Beneficiary has a Property Right,

enforceable in court, then their creditor has a right to ask the court to make a distribution to satisfy the creditor claim

Mandatory Distribution and Ascertainable Standard TrustsBoth allow Beneficiary to have Property RightNeither protects against creditors

Discretionary Dynasty TrustThis type of Trust is the only type that

provides creditor protection for beneficiaries

3 TypesBeneficiary ControlledBeneficiary Controlled with Distribution

TrusteeFull Discretion of Independent Trustee

Beneficiary Controlled TrustIn California, a Beneficiary who is the sole

trustee of a trust must abide by the health, education, maintenance, and support standard. Cal. Probate Code 16081(c)Creates a Property Right

Therefore, this type of trust does not offer much asset protection

However, we can allow the Trust Protector to have the right to remove the Trustee, and replace them with an Independent Trustee having full discretion, which may solve this problem

Beneficiary Controlled with Distribution TrusteeBeneficiary is managing trustee and

appoints a co-trustee responsible for making distributionsBeneficiary retains right to remove and

replace all trusteesThis probably eliminates the application of

Cal. Probate Code 16081(c).Co-Trustee may use Discretionary

Distribution standardThis should not create a Property Right in

the Trust

Fully Discretionary Trust with Independent TrusteeIndependent TrusteeSole, Absolute and Unreviewable Discretion

to make distributions as they see fit.Still must be made “reasonably” under

California lawMost powerful asset protectionThere is no real possibility of a “Property

Right”Creditor attack is really not possible,

according to case law.

Controlling the TrusteeHow do you make sure the Trustee makes

prudent decisions?Method 1

Leave a Letter of WishesAllow Trust Protector to Remove and Replace

if Letter of Wishes is Not FollowedMethod 2

Allow Beneficiary to Remove and Replace the TrusteeAlmost like the beneficiary is in control, no real risk

of being labeled a “Property Right”

SummaryMost Trusts are Mandatory Distribution

Trusts or Ascertainable Standards TrustsThese Trusts create a Property Right in the

Trust AssetsThis Property Right makes the trust

susceptible to creditorsThe only way to avoid creditor issues is

through Discretionary Trust