Non-Tax Uses of Trusts
Mr. Dickey and attorney Ryan Beasley address the issue of how trusts can be used to protect property from the claims of creditors and predators. (For purposes of this article, capitalized terms have the same meaning as in the prior installment of this article.)
Protecting trust property from the claims of creditors and predators. In speaking of claims by creditors and predators against property held in trust, we normally hear about two major types of trusts, “Self-Settled Trusts” and “Third Party Trusts.”
Self-Settled Trusts are trusts created where the Grantor (the person who creates the trust) is also a beneficiary of the trust. A Third Party Trust, on the other hand, is one where the Grantor establishes a trust for beneficiaries other than himself or herself (for example, for his or her spouse, children, and/or other descendants). Georgia law does not look kindly upon efforts of Settlors (the terms Settlor and Grantor are interchangeable) to defeat the claims of their own creditors by creating Self-Settled Trusts. For example, the Georgia Code states that “[d]uring the lifetime of the settlor, the property of a revocable trust shall be subject to the claims of the settlor’s creditors.” O.C.G.A. § 53-12-82(1). If the Settlor creates a Living Trust and makes it Irrevocable, the creditors of the Settlor may reach the “maximum amount that can be distributed to or for the settlor’s benefit during the settlor’s life or that could have been distributed to or for the settlor’s benefit immediately prior to the settlor’s death.” O.C.G.A. § 53-12-82(2). Thus, even if the property in a Self-Settled Trust is placed in the hands of an independent Trustee with discretion, but not any obligation, to pay the assets back to the Settlor, the creditors of the Settlor can still reach the maximum amount that the Trustee could, in the full exercise of his or her discretion, pay to the Settlor.
After the death of a Settlor, “the property of a trust that was revocable at the settlor’s death or had become irrevocable as the result of the settlor’s incapacity, shall be subject to the claims of the settlor’s creditors to the extent that the settlor’s probate estate is inadequate” to pay the debts. O.C.G.A. § 53-12-82(3).
Thus, it is very difficult for a Settlor to transfer his or her assets to a trust which is Revocable (or Irrevocable but provides lifetime benefits to the Settlor) and put those assets beyond the reach of his or her own creditors.
Note, however, that Georgia law is far more favorable to a debtor who is a beneficiary of a trust (i.e., a debtor/beneficiary) in the case where the beneficiaries of such trust do not include the Settlor. Such trusts are called Third Party Trusts and include, for example, Testamentary Trusts that might be set up by a wife for her husband, children, and/or other descendants following her death.
Georgia law seeks to strike a fair balance between the claims of creditors and the right of a person to leave his or her assets only to persons he or she chooses. As described above, a Settlor cannot defeat his or her own creditors by transferring his or her assets to a Self-Settled Trust. However, in Third Party Trusts, the creditors of a beneficiary (who is not the Settlor) of such trust should not be able to seize assets which the beneficiary never directly owned and transferred.
With respect to a Third Party Trust, a Settlor may, in general, dispose of his or her property as he or she sees fit in a manner which shields the property from the claims of the beneficiaries’ creditors. The property passing pursuant to a Third Party Trust was not originally the property of the beneficiary(ies) of such trust and, therefore, should not have to be available to pay the debts of the beneficiary(ies). The intent of the Settlor is paramount. If the Settlor does not wish for his or her property to be seized by the creditors of a third party beneficiary, then that intent generally will be respected if the instrument is properly drafted (because, in most circumstances, the Settlor has the right to benefit only the persons he or she chooses and has no duty or obligation to pay the debts of the beneficiary).
O.C.G.A. § 53-12-81 entitled Limitations on creditors’ rights to discretionary distributions provides in pertinent part: “[a] transferee or creditor of a beneficiary shall not compel the Trustee to pay any amount that is payable only in the trustee’s discretion regardless of whether the trustee is also a beneficiary.” (Emphasis added.) This Section does not apply to the extent, if any, that a proportion of the trust property is attributable to the beneficiary’s own contribution. To that extent, the beneficiary would be considered a Settlor.
Thus, if the Trustee has the sole discretion to determine whether a payment of income or principal may be made to a beneficiary and the Settlor is not the beneficiary, then the creditors of that beneficiary cannot reach the assets of the trust unless and until they are paid out to such beneficiary. Even in a Third Party Trust, however, the creditors of a non-Settlor beneficiary can reach the income or principal if the debtor/beneficiary has an absolute right to receive the distribution (for example, if the Trust does not leave it in the Trustee’s discretion but rather requires that all income be paid to the beneficiary). In that event, the creditors can reach the income whether or not it is actually distributed. It should be noted again the interplay between the rights of creditors versus the right of a Settlor/decedent to leave property as he or she wishes: under O.C.G.A. § 53-12-81, the provision does not apply to the extent the beneficiary made a contribution of property (or is a Settlor) to the Trust.
O.C.G.A. § 53-12-80(e) provides that:
[a] provision in a trust instrument that a beneficiary’s interest shall terminate or become discretionary upon an attempt by the beneficiary to transfer it, an attempt by the beneficiary’s creditors to reach it, or upon the bankruptcy or receivership of the beneficiary shall be valid except to the extent of the proportion of the trust property attributable to such beneficiary’s contribution [i.e., to the extent the beneficiary becomes a Settlor].
(Alteration to original.)
In other words, even if the payment of income is mandatory in a Third Party Trust, a provision may be included in the instrument to terminate the distributions or change them from mandatory to discretionary if a beneficiary’s creditor is looming. In this case, the provision could give the Trustee the discretion to pay such distributions to the beneficiary’s spouse or children or to accumulate all or part of the income. In any event, the creditor could not reach the trust property except to the extent actually paid to the debtor/beneficiary.
If an individual does not wish to place assets in a trust for an extended period of time but is only concerned about attempting to thwart the claims of his or her own creditors and predators upon death, then under O.C.G.A. § 53-12-82 (3), the simple re-titling of assets or the naming of beneficiaries for assets may be sufficient to defeat the claims of a debtor’s own creditors. This Section provides that “[p]ayments that would not be subject to the claims of a settlor’s creditors if made by way of beneficiary designation to persons other than the settlor’s estate shall not be made subject to such claims. . . . .” O.C.G.A. § 53-12-82(3). This means that, in those instances where beneficiaries are named or “designated” (such as on insurance policies, retirement plans, annuities, transfer on death accounts, payable on death accounts, joint tenancy with right of survivorship accounts, etc.), the assets will not be in the decedent’s probate estate and will not, absent other circumstances, be subject to the claims of creditors of the deceased debtor. It should be kept in mind that, notwithstanding the above, if one wishes to avail himself or herself of the above-described planning techniques, he or she should engage in the planning prior to incurring the subject liability.
As will be discussed in more detail in a subsequent installment of this article, the person who makes the transfer of an asset (whether in trust, outright or by beneficiary designation) and desires to put it beyond the reach of his or her own creditors, must not run afoul of the UNIFORM VOIDABLE TRANSACTIONS ACT (the “Act”), O.C.G.A. 18-2-70 et. seq. (primarily §§18-2-74 and 18-2-75). In a nutshell, this Act provides that if a person (the transferor) transfers property to a donee by a gift or to a trust (or by beneficiary designation or retitling), with a specific intent of hindering or defeating a creditor, or if the transferor is rendered insolvent by the transfer, the transfer may be set aside by a court as a “voidable transfer” so the creditor can reach it. But, assuming one does not run afoul of this Act, assets transferred to a trust for a beneficiary receive a much broader level of protection against claims of that beneficiary’s creditors. Thus, the time for an individual to engage in planning to insulate assets from the claims of creditors, is before those creditors appear on the horizon, and while the transferor is solvent.
David H. Dickey is a partner at Oliver Maner LLP and concentrates his practice in the areas of Estate Planning, Business Law, Business Entities, Probate & Estate Administration and Taxation. He can be reached by email at email@example.com and by phone at 912.236.3311.
Ryan Beasley is an associate at Oliver Maner LLP and concentrates his practice in the areas of Estate Planning, Business Law, Business Entities, Probate & Estate Administration and Taxation. He can be reached at firstname.lastname@example.org and by phone at 912.236.3311.