Creditors and Self-Settled Trust in New Jersey
Question: Can a self-settled trust shield creator’s assets from claims by creditors?
Answer: First what is a self-settled trust? It is a trust that is funded by the creator during creator’s lifetime and where the creator is also the income and/or principal beneficiary.
Now for the answer, under NJSA 3B:11-1(a) any reserved right in the creator to either income or principal is reachable by the creditors of the creator. Note that the statute does not distinguish between revocable or irrevocable trusts, since a revocable trust is simply a reservation of property rights to the entire trust estate in the creator of the trust.
So how can a creator of a trust shield assets from creditors while still being able to enjoy income and principal from the trust? Under NJSA 3B:11-1(b) this is accomplished by giving a Trustee discretion on whether to make distributions to the creator, without any reserved power in the creator to influence Trustee’s decision. Note that it does not matter that, as in the case of an intentionally defective grantor trust (IDIT), that the grantor/creator may be required to pay taxes on income generated by the trust estate. Everything hinges on who has the discretion to allocate income or assets from the trust. If it is the creator/grantor then the creditors have a claim, if it is the trustee, then creditors do not have a claim. Obviously the trustee will need to be someone other than the creator/grantor.