What you need to know about how to effectively protect your assets in California:
Self settled spendthrift trusts are a common topic in the world of asset protection, but their treatment under California law often leads to confusion. In California, self-settled trusts face significant legal limitations, particularly when creditors attempt to enforce judgments against the settlor. This article explores the legal framework surrounding self-settled spendthrift trusts in California, examining relevant statutes, case law, and practical implications for individuals considering these trusts as part of their financial planning.
Special thanks to Jay Adkisson for his detailed analysis on this topic in a Forbes article. His comprehensive exploration of California trust law has provided invaluable insights for understanding this complex area.
What Is a Self-Settled Spendthrift Trust?
A self-settled trust is a trust where the individual creating the trust (the settlor) is also a beneficiary. These spendthrift provisions are often used in estate planning and asset protection strategies. However, in California, the law does not provide the same protections for self-settled spendthrift trusts as it does for other types of trusts.
Under California Probate Code § 15304, a spendthrift clause in a self-settled trust is unenforceable against creditors of the settlor. This means that creditors can reach assets in the trust to satisfy the settlor’s debts, effectively nullifying the trust’s asset protection benefits.
Key Legal Limitations of Self-Settled Spendthrift Trusts in California
1. Creditors Can Reach Trust Assets
Probate Code § 15304(a) explicitly states that a spendthrift clause in a self-settled trust does not protect the trust’s assets from the settlor’s creditors. This principle has been affirmed in cases like In re Cutter, 398 B.R. 6 (B.A.P. 9th Cir. 2008), where the court ruled that creditors could access trust assets because the settlor was also a beneficiary.
2. Discretionary Distributions
When a trust allows discretionary distributions to a settlor/beneficiary, creditors may access the maximum amount the trustee could distribute to the settlor. However, this is capped by the amount the settlor contributed to the trust (§ 15304(b)). This rule ensures that creditors cannot claim more than the settlor’s contributions, but it still provides little protection for the settlor’s assets.
3. Revocable Trusts and Asset Protection
Revocable trusts, which are often used as estate planning tools, provide no asset protection for the settlor under California law. According to Probate Code § 18200, the assets of a revocable trust are available to the settlor’s creditors during their lifetime. Upon the settlor’s death, these assets become subject to claims against the settlor’s estate (§ 19001(a)).
4. Court Interpretation of Self-Settled Trusts
Courts in California can look beyond the language of the trust document to determine its true purpose. For example, in Sheean v. Michel, 6 Cal.2d 324 (1936), the court disregarded a trust that was ostensibly for the settlor’s children because the settlor retained control over the trust assets. This principle highlights the importance of the settlor’s level of control in determining the validity and enforceability of the trust.
Case Law Highlight: Kilker v. Stillman (2012)
In the pivotal case of Kilker v. Stillman (2012), the California courts reaffirmed their position that they do not recognize the validity of out-of-state asset protection trusts, such as Nevada or Wyoming Asset Protection Trusts, when applied to California residents. The court ruled that California’s public policy and laws supersede the protections offered by out-of-state trusts, rendering such trusts ineffective against creditor claims in California.
This case is critical for understanding the limitations of relying on out-of-state asset protection strategies when dealing with California-based assets or residents. For a full breakdown of this important case, see my detailed article on Kilker v. Stillman.
Practical Implications for Self-Settled Spendthrift Trusts
1. Asset Protection Challenges
In California, self-settled spendthrift trusts are ineffective for protecting assets from creditors due to the state’s strict laws. Furthermore, relying on Domestic Asset Protection Trusts (DAPTs) in states like Nevada or Wyoming are not a viable option for California residents, as California courts do not recognize the protections offered by out-of-state trusts. This was made clear in Kilker v. Stillman (2012), where the court invalidated the protections of a Nevada Asset Protection Trust for a California resident.
For California residents seeking effective asset protection, the most reliable options are:
• Purely Foreign Trusts: Jurisdictions like the Cook Islands offer robust legal protections, including short statutes of limitations, high burdens of proof for creditors, and non-recognition of foreign judgments.
• Hybrid Trusts (e.g., The Bridge Trust®): These trusts combine the flexibility and accessibility of a domestic trust with the protective features of an offshore trust. A Bridge Trust® remains domestic until a legal threat arises, at which point it seamlessly transitions offshore for enhanced protection.
By utilizing a foreign trust or a hybrid trust, California residents can effectively safeguard their assets while remaining compliant with California law. However, it is essential to consult an experienced attorney to ensure proper structuring and adherence to all legal requirements.
This link is to a master strategy presentation that I gave for Tony Robinson, the host of Bigger Pockets Rookie, and his investment group at Alpha Geek Capital:
2. Mandatory vs. Discretionary Distributions
Mandatory distributions are particularly vulnerable to creditor claims, as creditors can intercept 100% of these distributions under Probate Code § 15301. In contrast, discretionary distributions offer some level of protection, as creditors can only claim 25% of future distributions under § 15306.5(b).
3. Alter Ego Liability
When a settlor retains excessive control over trust assets, courts may disregard the trust as a separate legal entity and treat it as the settlor’s “alter ego.” This allows creditors to access trust assets as if they were owned outright by the settlor. Cases like In re Schwarzkopf, 626 F.3d 1032 (9th Cir. 2010), illustrate how courts apply the alter ego doctrine to trusts.
4. Fraudulent Transfers and Voidable Transactions
Creditors can challenge transfers to self-settled trusts under California’s Voidable Transactions Act (Civil Code § 3439.01 et seq.) if the transfers were made with intent to defraud creditors or without reasonably equivalent value. The statute of limitations for such claims can extend up to seven years or more under certain circumstances.
Conclusion
Self-settled spendthrift trusts in California are severely limited by law and offer little to no protection against creditors. Courts will scrutinize these trusts closely, particularly when the settlor retains control or transfers assets under questionable circumstances. For effective asset protection, consult an experienced attorney who can tailor a strategy using legally sound tools, such as offshore trusts or hybrid structures like the Bridge Trust®.
For personalized advice on trust structures and asset protection strategies for California residence, contact Bradley Legal Corp. today, for a legal consultation at (888) 773-9399.
By: Brian T. Bradley, Esq.
