A good solution to many Estate Planning and asset protection problems is a trust. In past visits I’ve told you about many different types of trusts and the problems they can solve. But what I haven’t focused on is where to set up your trust. This question is almost as important as the type of trust you create. In this visit I’m going to explain why the trust location is important and suggest some locations to consider.
A trust is considered a separate legal person, and the trust can be a “resident” of any state or country. Even if you and all the beneficiaries live in one state, the trust can be elsewhere. Most people automatically set up trusts at their local bank or trust company, or at the bank recommended by the estate planning attorney. But don’t rush this decision.
Some states are very friendly to trusts. Your heirs might save a bundle in state taxes by locating the trust out of state. Some states burden trusts with a lot of paperwork, including public reporting. You don’t want these states if you want to keep down costs or maintain some privacy. Also, some states allow a trust to last forever, which is important if you want to set up a dynasty trust. But other states limit the term of a trust. A state also might put restrictions on how the trust can be invested. Finally, some states provide better protection of your trust assets from creditors than do other states.
In the past, estate planning professionals and asset protection specialists often said that the ultimate trusts were located in countries such as the Cook Islands, Belize, the Isle of Man, and the Bahamas. Trusts in these countries provide the tax benefits of a U.S.-based trust with the added benefit that the creditors of you or your heirs would have a heck of a time breaking the trust to get the assets it holds.
But disadvantages abound with offshore trusts. They are very expensive to set up and usually must be placed in an obscure little country. Many people often aren’t comfortable with offshore lawyers and trust companies.
Also, the trusts rely on inconvenience, expense, and the fact that the host country won’t respect a court judgment in the United States to protect your assets. A creditor who can handle the expense might get to your money, and the U.S. might some day put pressure on these countries to change their ways. Besides, you have to reveal foreign trusts on your tax return and other financial documents. People fear that might set off bells and whistles at the IRS and carry a stigma of sleaze with others who learn of the foreign trust.
Now, you apparently don’t have to go outside the U.S. to get many of the benefits of an offshore trust. Alaska and Delaware recently overhauled their trust laws to make them very friendly to anyone in the U.S. Some say this gives you most of the benefits of an offshore trust at one half to one third of the cost. There are two provisions of these laws that particularly attract well-off Americans.
One provision seems to allow you to give assets away for tax purposes but still be able to tap the assets in a crunch.
Here’s how it works. You put property in the trust and do not retain a right to receive any future distributions from the trust. But you remain eligible to receive distributions if the trustee decides you need them. In most states, this would allow creditors to tap the trust and also cause the trust to be included in your estate.
But in Alaska, the trust remain protected from creditors except in four situations. Two cases are debts that arose before the trust was created and child support payments. Another case is when the creator has the right to trust assets. And the final exception is when the creator retains the right to revoke the trust and recapture the assets.
But the creator can remain eligible to receive distributions at the trustee’s discretion and still have the trust assets remain out of the reach of creditors. Even better, lawyers who advocate Alaska and Delaware trusts say because of this provision trust assets will be out of your estate for tax purposes even if you retain eligible to receive future discretionary payments.
This solves a major estate planning problem. The only way to get property out of your estate is to give it away. In many cases, gifts are made to an irrevocable trust under which the creator is ineligible to receive payments. The requirement that you permanently give away assets keeps many people from setting up a trust.
But some estate planning advisors are saying that the assets stay out of your estate as long as under local law your creditors could not touch the assets. That would mean you could “give” the assets away to an Alaska trust, have those assets out of your estate, yet be able to get payments from the trust at the trustee’s discretion if you spent or lost your other assets.
Not everyone agrees with this interpretation of the estate tax law, and the IRS has not ruled on it. In addition, it is not clear that the trusts will protect your assets from creditors. If a court in another state rules that your creditors are entitled to tap the trust, then under the Constitution, the Alaska or Delaware trust probably has to comply with that ruling. That also has not been tested.
Using these new trusts for estate planning or asset protection is not a sure thing. The only way to get certainty is to wait for IRS rulings and court decisions. Some asset protection specialists are saying that they will use Alaska trusts in combination with other devices or with an escape valve. For example, the Alaska trust might be automatically moved to a foreign country if a creditor gets a judgment against you. Or the trust might be combined with a family limited partnership. Or the Alaska trust might be created by an offshore trust that you create. But the cost of those strategies will be higher, so a lot of money must be at stake.
Alaska, Delaware, and South Dakota are good places to consider for your trust even if you don’t rely on the ultimate asset protection and estate planning provisions.. These states have low taxes, allow perpetual trusts, and generally have encouraged trusts to be established there.
To establish a trust in another state, you generally have to use a trustee located in that state, place at least some assets there, and probably have the assets managed from that state. These all are costs you have to incur anyway, but they could be higher out of state.
If you have a sizable estate, it is worth consulting with an estate planner who can help you consider which state would be best for your trust after reviewing state taxes, creditor protection, convenience, privacy, and time limits. But make sure the benefits are real and not based on forecasts of how courts will act in the future.