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Law Library

Revocable Grantor Trusts An Estate Planning Tool, Not An Asset Protection Strategy

Abraham E. Brustein
Abraham E. Brustein

For several decades, lawyers have been recommending to their‑clients the use of a revocable trust as part of an overall estate plan, especially for clients who wish to avoid probate and whose assets at death foreseeably could exceed the current threshold of the unified estate and gift tax credit. A typical revocable trust which estate planners recommend has the following attributes:

The client (who is the "Grantor" or "Senior") conveys substantially all of his assets to himself as the trustee of his newly created trust. The client is also the beneficiary of the trust during his lifetime. These trusts are referred to as "Grantor Trusts." The client may alter, amend or even completely revoke the trust during his lifetime. Upon the client's death or disability, the trust becomes irrevocable. Immediately, a new trustee, often the spouse, takes control of the trust. At death, the trust assets are allocated between a marital trust and an exemption trust (usually a family trust) to give effect to the estate plan which the client formulated during his lifetime.

The principal goal of a Revocable Grantor Trust is to provide a mechanism to enable a surviving spouse or other heirs to obtain control of the Grantor's assets at his death or disability without the intrusion of the probate process. Other significant benefits attendant to this estate planning device are the ability of the Grantor to control the use of the trust assets prior to his death or disability because the grantor‑ is both the trustee and the beneficiary of the trust during his lifetime. At his death, the Grantor's assets are administered outside of probate by the successor trustee. After the Grantor's death, the trust assets are administered for the benefit of the successor beneficiaries of the trust. While use of the Revocable Grantor Trust is an excellent way to avoid the intrusion of probate at death or disability, it is important to remember that it is an estate planning device. It is not an asset protection device.

Over the past few months, when assisting my clients in dealing with problems with their creditors. I was surprised on several occasions to find that the clients believed they had insulated their assets from their creditors through the use of a Revocable Grantor Trust. Clearly, there are misconceptions in the marketplace about what, if any. protection results from the creation of a self‑settled Grantor Trust. Hopefully. I can clarify for our clients how these trusts are treated under the Illinois law of debtor‑creditor relations.

One of the hallmarks of a trust is the spendthrift clause, which allows the trustee to insulate trust assets, including distributions otherwise payable to the beneficiary, from the creditors of the beneficiary. However, Illinois statutes provide that a creditor holding a judgment against a beneficiary (who is also the Grantor) of a self‑settled trust may enforce the judgment by executing against the assets owned by the trust. Creditors of the Grantor‑beneficiary of a self‑settled trust can reach both the assets owned by the trust and distributions payable to the beneficiary to satisfy a judgment. This is true regardless of whether or not the Grantor has reserved the power to revoke the trust. A trustee may not withhold trust property or distributions which are otherwise payable to a Grantor‑beneficiary of a self‑settled trust under color of a spendthrift clause. Quite simply, in Illinois the spendthrift provisions of a self‑settled trust are legally unenforceable with regard to the Grantor‑beneficiary.

Illinois statutes provide that a creditor holding a judgment against a beneficiary (who is also the Grantor) of a self‑settled trust may enforce the judgment by executing against the assets owned by the trust. Creditors of the Grantor‑ beneficiary of a self‑settled trust can reach the assets owned by the trust and distributions payable to the beneficiary to satisfy  judgment. This is true regardless of whether or not the Grantor has reserved the power to revoke the trust.

In my opinion, especially in the case of a revocable self‑settled trust, these principles merely reflect common sense. I would not expect the law to countenance or condone a person being able to avoid legitimate creditor claims merely by making a"gift" to himself, using a trust as the vehicle to make the gift. In the context of a revocable self‑settled trust, there is really no transfer of ownership at all until the trust becomes irrevocable at the death of the Grantor. At that point, the Grantor (i) can no longer rescind or revoke the trust and (ii) is no longer the beneficiary. Therefore, at that moment, the trust becomes a valid asset protection mechanism. The successor beneficiary's creditors cannot seek recourse against trust assets because the spendthrift clause will be legally enforceable at the death of the Grantor. Also, the Grantor's creditors will have no recourse against trust assets, assuming the original transfer into the trust was not a fraudulent conveyance, because the Grantor no longer has control of the trust assets or the benefit of the trust assets.

I advise clients to use a revocable self‑ settled trust as part of a complete estate plan, but to understand the assets and income attributable to the property in the trust are subject to creditor claims to the same extent as if the trust did not exist. Trusts are among the most powerful tools available for a Grantor who is not insolvent to transfer wealth to others, while legitimately keeping the assets transferred into the trust outside of the reach of the successor beneficiary's creditors. In Illinois, revocable self‑settled trusts do not accomplish this asset protection goal vis‑a‑vis creditors of the Grantor.