Self-settled trusts

Key points about self-settled trusts

• DAPTs are used to help professionals in fields with a lot of liability protect their personal assets without moving them offshore.

• The grantor of the trust is also one of its beneficiaries, so though they can still benefit from the assets, they are a separate entity and protected from creditors.

• These assets are not part of the probate estate after the person passes away, but they may be part of the taxable estate.

• This kind of trust is still very new and laws can change, so seek the advice of an attorney.

When a loved one passes away, you may suddenly be exposed to a whole new world of financial arrangements that can seem both foreign and intimidating. Irrevocable self-settled trusts, also known as domestic asset protection trusts (DAPTs), are a method of safeguarding one’s assets from potential creditors. If your loved one had one of these, it may be important to understand how it works.

When these trusts are used

Typically, DAPTs are created by those in high-risk professions that involve potential liability for damages or losses from their clients or business associates. So doctors, lawyers, accountants, architects, builders, executives, and other professionals in fields in which there is frequent litigation may choose to protect their assets in this kind of trust. 

Self-settled trusts only exist in a minority of states, so people sometimes form them in states other than the one where they reside. However, if real estate in their home state is placed in the trust, local laws may take precedence, so a DAPT may not effectively safeguard it from creditors. Additionally, if a vehicle is placed in the trust, this trust does not protect the operator of the vehicle from liability if they have an accident.

How does a self-settled trust work? 

Most trusts have three parties: the grantor who creates the trust, the trustee who manages the assets in the trust, and the beneficiary who receives assets from the trust. However, in a self-settled trust, the grantor is also the beneficiary, or one of the beneficiaries.

In creating a self-settled trust, the grantor transfers ownership of assets such as cash, securities, limited liability companies, recreational vehicles, or even household objects such as furniture to the trust. Because the grantor is also the beneficiary of the trust, they may continue to get certain benefits of the trust, such as any interest or other income the assets in it generate. And depending on the terms of the trust and the duration of the potential liability the grantor faces, they may receive some or all of the assets from the trust at a later date. 

However, from the moment the trust is created, it is irrevocable, meaning even though the grantor is a beneficiary, they cannot change its terms in any way. This ensures that the trust is legally an independent entity that is not owned by the person for the duration of the trust. Thus the assets in it are not subject to the grantor’s personal debts, which is how they work to protect their assets from creditors. And if they pass away, like most trusts, they do not go through probate. There are cases in which a self-settled trust may be under an obligation to pay certain creditors, such as child support, alimony, state and federal taxes, and court orders or judgments. And these creditors may be able to claim their debts from the trust after the person has passed away, despite it not being part of the probate estate.

Tax implications 

While they may not be subject to probate, are self-settled trusts part of the taxable estate when it comes to calculating state and federal estate taxes? As with most matters of complex tax law, the answer is that it depends. Factors include applicable federal and state laws, the size of the trust and of the estate, and who the beneficiaries are. 

Generally speaking, creating a DAPT may be a way of planning ahead of time to reduce the size of one’s taxable estate, but how effectively it does so depends on how the trust was drafted. Self-settled trusts are also a relatively new legal structure without a great deal of case law around them, and each state handles them differently, especially when it comes to situations where the trust is in one state but the assets are in another.

Therefore, if you are seeking to understand the implications of a loved one’s trust for their estate now that they have passed away, it is highly recommended that you seek the advice of a trusts and estates lawyer. If it is possible to contact the original lawyer or law firm that drafted the trust, they will be your best point of contact when dealing with it. 

Creating a safe method of passage for the assets your loved one spent a lifetime working hard to obtain can be a profound gift of love to their family and friends. And part of honoring their memory will be following the correct steps to allow them to be bequeathed according to their wishes.

You may be eligible for free bereavement support. Empathy can help with everything from funeral planning to estate administration, with step-by-step guidance and real-time expert support. Many people get free premium access to Empathy as a benefit with their life insurance claim. We partner with New York Life, Guardian Life Insurance Company, Bestow, Lemonade, and other leading carriers. When you make your life insurance claim, talk to your representative about whether Empathy is a benefit they offer.