Creditors' rights in property subject to a beneficiary's right of withdrawal

• Pages: 139-168
• Date: 01 July 2022
• Author: S. Alan Medlin,F. Ladson Boyle
• Subject Matter: Derecho Público y Administrativo

CREDITORS’ RIGHTS IN PROPERTY SUBJECT TO

A BENEFICIARY’S RIGHT OF WITHDRAWAL

S. Alan Medlin & F. Ladson Boyle

Authors’ Synopsis: Estate plans often give trust beneficiaries powers of

withdrawal for both tax and nontax reasons. For tax reasons, these

powers of withdrawal are typically limited, such as a “five or five

power” or a so-called Crummey power commonly pegged to the annual

gift tax exclusion amount. A central issue with limited powers of with-

drawal is the right of a beneficiary’s creditor to reach trust property

subject to the beneficiary’s power to withdraw. Recent uniform statutes,

such as the Uniform Trust Code and the Uniform Power of Appointment

Act, as well as the Restatement (Third) of Trusts, provide guidance. This

Article discusses the typical reasons for creating powers of withdrawal

and the historical and recent treatment of the rights of creditors of trust

beneficiaries with powers of withdrawal, along with some planning

considerations.

I.INTRODUCTION .......................................................................... 140

II.THE TAX ORIGIN OF LIMITED POWERS ................................... 142

A.Five or Five Powers .............................................................. 142

B.Crummey Powers - Annual Exclusion Gifts ........................ 143

III.CREDITORS RIGHTS - STATE LAW ........................................... 144

A.Common Law ....................................................................... 144

B.UTC Section 505 and Creditors of Settlors .......................... 146

1.Revocable Trusts ............................................................ 146

2.Irrevocable Trusts .......................................................... 147

C.UTC Beneficiary Withdrawal Rights ................................... 148

IV.EFFECT OF A SPENDTHRIFT PROVISION ................................... 151

V.WHICH STATES HAVE ADOPTED UTC SECTION 505(B) ......... 159

A.Uniform Powers of Appointment Act .................................. 162

VI.THE TAX DIFFERENCE .............................................................. 163

VII.PLANNING THAT MIGHT ADDRESS THE CREDITOR ISSUE ...... 165

VIII.CONCLUSION .............................................................................. 167

 S. Alan Medlin, David W. Robinson Professor of Law, University of South Carolina

School of Law, https://sc.edu/study/colleges_schools/law/faculty_and_staff/directory/med

lin_alan.php [https://perma.cc/NSD9-RS3Y].

 F. Ladson Boyle, Charles E. Simons, Jr. Distinguished Professor Emeritus of

Federal Law, University of South Carolina School of Law, https://sc.edu/study/coll

eges_schools/law/faculty_and_staff/directory/boyle_ladson.php [https://perma.cc/2TAE-

WQ7N].

140 57 REAL PROPERTY, TRUST AND ESTATE LAW JOURNAL

I. INTRODUCTION

Trusts sometimes permit a beneficiary to withdraw a limited portion

of property held in the trust. Historically, these trusts typically allow

beneficiaries to withdraw, on an annual basis, the greater of $5,000 or 5%

of the value of the trust assets. This power of withdrawal is commonly

called a “five or five power.”1 In addition to five or five powers, granting

a trust beneficiary a right to withdraw some portion or all of the new

transfers made to a trust is common when the donor seeks to qualify the

gift to the trust for the federal gift tax annual exclusion under Internal

Revenue Code (IRC) section 2503.2 This latter type of withdrawal power

is commonly called a “Crummey Power,”3 from the Ninth Circuit opinion

in Crummey v. Commissioner,4 which sustained the annual exclusion

based on a limited withdrawal right.5 Both rights are discussed in greater

detail in Parts II.A and II.B.

However, when a beneficiary has a power or right to access the

principal of the trust, even a power or right limited by time and amount,

the question arises whether creditors of the beneficiary may also reach or

attach the trust assets. The treatment of the rights of creditors of a

powerholder has been checkered and perhaps occasionally illogical. Most

courts determine the rights of creditors depending on the type of power the

powerholder holds. Often, the cases deal with claims against the estate of

the powerholder, when creditors pursue the appointive assets when the

powerholder’s probate estate is otherwise insufficient to pay the

powerholder’s debts. Absent a statute to the contrary, many courts have

permitted creditors of the estate of a holder of a general power to attach

trust assets if two conditions are satisfied: the powerholder must exercise

the power gratuitously and the estate of the powerholder is otherwise

insufficient to pay the claim.6 However, creditors have typically not been

1 See infra Part II.A; see also HOWARD M. ZARITSKY, TAX PLANNING FOR FAMILY

WEALTH TRANSFERS DURING LIFE: ANALYSIS WITH FORMS ¶ 4.08(3)(j)(i) (5th ed. 2022).

2 See I.R.C. § 2503(b).

3 See infra Part II.B; For a more complete discussion of Crummey powers of

withdrawal, see ZARITSKY, supra note 1, ¶ 4.08.

4 397 F.2d 82 (9th Cir. 1968).

5 See id.

6 See Slayton v. Fitch Home, 200 N.E. 357 (1936); Ward v. Marie, 68 A. 1084 (N.J.

Eq. 1907); Clapp v. Ingra-ham, 126 Mass. 200 (1879); In reBartram’s Estate, 42 Pa. 330

(1862); Johnson v. Cushing, 15 N.H. 298(1844); Roy Lee Steers, Jr., Note, Creditors’

Ability to Reach Assets Under a General Power of Appointment, 24 VAND. L. REV. 367

(1971) [hereinafter Note, Creditors’ Ability to Reach Assets]; cf. In reHagen’s Estate, 85

Pa. Super. 123 (1925), aff’d, 32 A. 175 (Pa.Super. Ct. 1926) (discussing how appointive