When the State Attacks a Discretionary Trust

An enormous opportunity for asset protection planning in Michigan and other states involves using trusts. It is quite common that a settlor of a trust will establish a trust with the goal that creditors of the trust’s beneficiaries cannot reach trust assets to satisfy their claims. Occasionally the government is the creditor. In a recent Michigan case the State Treasurer sought reimbursement from a trust for the costs of incarcerating a trust beneficiary.

The Treasurer relied on a state statute providing that persons in possession of an inmate’s assets must turn over such assets in response to a court order. The trust described the duties of the trustee as follows: “The Trustee may distribute such amounts of the income and principal from the trust property and estate as the Trustee, in its sole and uncontrolled discretion may deem to be in the best interest of the beneficiary…”. The court determined this was a discretionary trust and that creditors cannot reach a beneficiary’s interest in a discretionary trust because of the nature of his interest.

Various other arguments of the Treasurer failed including a public policy argument. The decision also pointed out that a trust beneficiary can be even more protected if the trust contains a spendthrift clause. This case is particularly important for the Michigan asset protection lawyer because it illustrates that a determined creditor with substantial funding and status cannot reach the assets of a properly drafted discretionary trust.

As a very effective strategy in protecting debtors, make sure that a future inheritance is not paid outright to the debtor but instead is held in a discretionary spendthrift trust. Same too with life insurance trusts and spousal trusts. The use of this type of trust can be extraordinarily useful and also provide a source of funds for a very favorable discounted payoff of the debt.