On July 9th, 1997 the Delaware Qualified Disposition Act was enacted. This Act was created to provide asset protection for self-settled Trusts created through Delaware law. A self-settled Trust is a Trust where the person who created and funded the Trust is also a beneficiary of the Trust. Before the creation of this Act there was no protection for assets contributed to a self-settled Trust created in Delaware. Prior to this Act, the Grantor’s creditors and/or debtors had the ability to pierce the Trust to recover monies, debts or judgments owed from the Grantor.
There are many reasons why someone would want to seek asset protection through an Asset Protection Trust. An individual in a highly litigious profession would seek asset protection from any future liability owed from a lawsuit they might be a part of due to their profession. This would be appropriate for individuals in the medical field, lawyers, and accountants. An individual who has recently inherited a large amount of money might seek asset protection from potential future creditors/debtors. This type of Trust can also be utilized as an alternative to a prenuptial agreement.
A Delaware Asset Protection Trust must meet the following requirements;
- The Trust must be Irrevocable with a Delaware Trustee serving at all times. The Trustee can be a Delaware Corporate Trustee, or an individual located in Delaware. It is possible to add a Co-Trustee that is not located in Delaware as long as there is a Delaware Trustee in place. If there a two Trustees, it’s important to ensure the situs (administrative law) is listed as Delaware in the Trust agreement.
- The validity, construction, and administration for Trust must be based on Delaware law.
- The Trust is required to have a Spendthrift Clause which should include reference to the Bankruptcy Code. A spendthrift clause protects the Trust from future creditors of the Grantor/Beneficiary.
To ensure that that the Trust provides adequate asset protection, the following items below must be considered;
- Ensure than no creditor had made a claim against the Grantor before the Grantor has made a qualified disposition to the Trust.
- A creditor can make a claim within four years after the Grantor has made a qualified distribution to the Trust.
- A qualified disposition is defined as a transfer, conveyance, or assignment of property from the Grantor to the Trust.
The Grantor of an APT does not lose total control over the Trust, as the Grantor can still retain the following powers in the Trust Agreement:
- The power to veto distributions from the Trust
- Retain a lifetime or testamentary limited power of appointment over the Trust assets.
- The power to receive income and/or principal of the Trust, although, the Grantor cannot have the power to direct distributions.
- The power to remove and/or replace a Trustee or advisor. An advisor could be a Distribution Advisor, Investment Advisor, or Trust Protector.
- The Grantor can be given a testamentary power to direct the Trustee to pay any expenses associated with the Grantor’s Estate at death.
- To appoint a designated representative for any of the Trust beneficiaries, and to also serve as the designated representative.
- The ability to be reimbursed for income taxes owed by the Trust by the Grantor on a mandatory or discretionary basis.
- To serve as Investment Advisor for the Trust and have control over the investment decisions for the Trust.
In creating a DAPT the following should be avoided;
- The Grantor should not be named as Trustee or Co-Trustee.
- The Grantor cannot receive assets from the Trust based on a specific time period listed in the Agreement.
- No Trustee or advisor should have the power to terminate the Trust.
- The Trust should not own real property located in any state other than Delaware.
A DAPT should be created to provide asset protection, and there should be no expectation for the Trustee to distribute funds from the Trust soon after the initial contribution to the Trust. The Grantor will need to ensure they have sufficient assets held outside of the Trust. In most situations, the assets the Grantor contributes to the Trust should not be more than 30% to 50% of their total net worth. The Grantor will also need to confirm they have no existing creditors claims prior to funding the Trust. Most Trustees will require the Grantor to sign an Affidavit of Solvency and Indemnity Agreement confirming the items listed above.
A Delaware Asset Protection can also provide significant tax savings. A Delaware Incomplete Non-Grantor (DING) Trust is a type of Asset Protection Trust that can be structured to avoid state taxation. The Grantor would contribute highly appreciated assets, which could include a business interest, to the Trust. The Delaware Trustee would then sell the assets contributed. In most instances, if the Trust does not have any Delaware beneficiaries, the sale would not be subject to state tax in Delaware or in the Grantor’s state of residence. Currently New York does not allow its residents to create DING Trusts to avoid state taxation.
There are a lot of factors to consider when creating a Delaware Asset Protection Trust. This type of Trust can provide adequate asset protection in addition to tax benefits. I would suggest having a discussion with your Estate planning attorney before considering this type of Trust. I would also suggest engaging a Delaware attorney in the drafting of the Trust Agreement to ensure the Trust includes the Delaware law created through the Delaware Qualified Disposition Act.
If you should have any questions or want to discuss this further, please do not hesitate to reach out to me.
Keith Al-Chokhachy, CFP®, CTFA, ATFA
Vice President / New Business Development Officer
Phone: (302) 510-6027 / Email: firstname.lastname@example.org
*The posts expressed are views of FSTC and are not intended as advice or recommendations. For informational purposes only. FSTC does not offer tax, legal, or investment advice, professional counsel should be sought for tax or legal advice.