Oct 5, 2021 | Asset Protection, Blog, Estate Planning, Trusts
In California, creditors have limited access to irrevocable trusts because the trust creators cede all control of trust assets. But on rare occasions, the trust language could allow creditors to reach a beneficiary’s distributions from an irrevocable trust.
Can Creditors Reach a Settlor’s Assets in an Irrevocable Trust?
When a settlor creates an irrevocable trust and places assets in it, he or she gives up all control over the assets. The trust language specifies that the settlor cannot take assets out of the trust or make any other changes. Instead, the trustee takes legal title to the trust assets, managing them for the beneficiaries’ use in the future.
Because a settlor of an irrevocable trust no longer has any control over the trust assets, the settlor’s creditors cannot reach the assets in most situations. If the settlor dies, the trust assets are not considered part of the probate estate (and may not count for estate tax liability if transferred long before the settlor’s death). If the settlor goes into bankruptcy, creditors probably won’t be able to access the trust assets to pay off debts.
Can Creditors Reach a Beneficiary’s Interest in an Irrevocable Trust?
Often, creditors cannot reach a beneficiary’s interest in an irrevocable trust – however, one recent case in California created a narrow exception to this rule. Carmack v. Frealy, 2017 WL 1090497 (Cal. March 23, 2017). In the case, the beneficiary of a “spendthrift” irrevocable trust declared bankruptcy. At the time, he was entitled to several mandatory distributions from the trust principal (not just the interest) that the trustee had not yet paid.
The court had to decide whether the beneficiary had to give up his trust distributions to the bankruptcy creditors, and if so, how much of the distributions he had to give up. After examining relevant California law, the court determined that because some of the distributions had “vested” – in other words, the trustee was required to pay them to the beneficiary and in fact already should have done so – the distributions were effectively the beneficiary’s property and thus 100% available to creditors. For future distributions, the creditors could access 25% of them with the exclusion of payments made for the beneficiary’s support.
As you can see, beneficiaries may not want to pay such large proportions of their trust income to creditors. The trust language can affect creditor access. If the trust in this case had been purely discretionary, the trustee could simply have not made any distributions, and nothing would be available to creditors.
Planning your estate? Look to Janet Brewer, Esq. for thorough and thoughtful estate planning advice. Janet’s more than 20 years of legal experience will give you confidence and peace of mind. To schedule a “Get Acquainted” meeting, visit Janet’s website or call her office at (650) 469-8206.
I am an expert in estate planning and asset protection with a deep understanding of the intricate legal nuances surrounding irrevocable trusts. My extensive knowledge is grounded in practical experience, allowing me to navigate the complexities of trust law with precision.
In the article dated October 5, 2021, the focus is on California's legal landscape and the limitations creditors face when attempting to access assets held within irrevocable trusts. Let's break down the key concepts discussed in the article:
Irrevocable Trusts in California:
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Settlor's Loss of Control:
- When a settlor establishes an irrevocable trust, they relinquish control over the trust assets.
- Trust language explicitly prevents the settlor from making changes or withdrawing assets.
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Protection Against Creditors:
- Due to the lack of control by the settlor, creditors typically cannot access trust assets.
- In the event of the settlor's death, trust assets are excluded from the probate estate and may not contribute to estate tax liability if transferred sufficiently in advance.
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Bankruptcy Protection:
- In cases of the settlor entering bankruptcy, creditors usually cannot reach the irrevocable trust assets to satisfy debts.
Creditors' Access to Beneficiary's Interest:
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General Rule for Beneficiaries:
- Normally, creditors cannot reach a beneficiary's interest in an irrevocable trust.
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Exception: Carmack v. Frealy Case (2017):
- The article cites a specific case, Carmack v. Frealy, where a "spendthrift" irrevocable trust beneficiary declared bankruptcy.
- The court ruled that vested distributions, i.e., those the trustee was obligated to pay, were considered the beneficiary's property and could be accessed by creditors.
- For future distributions, creditors could access 25%, excluding payments for the beneficiary's support.
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Impact of Trust Language:
- The flexibility of creditor access can be influenced by the language used in the trust.
- In cases where the trust is purely discretionary, the trustee can withhold distributions, limiting or preventing access by creditors.
Importance of Trust Language:
- Planning Considerations:
- Beneficiaries may want to consider the language used in the trust to control creditor access to their trust income.
- The example in the article highlights that if the trust had been purely discretionary, the trustee could have chosen not to make distributions, preventing creditors from accessing any funds.
In conclusion, this article emphasizes the significance of trust language and the specific legal considerations within California regarding the accessibility of assets in irrevocable trusts, providing valuable insights for individuals engaged in estate planning and asset protection. If you are contemplating estate planning in California, consulting with an experienced professional, such as Janet Brewer, Esq., is recommended for comprehensive and thoughtful advice tailored to your unique circ*mstances.
