Investors often think of trusts as a way to transfer wealth or avoid probate. But certain trusts can be used for asset protection and may help families shield assets from potential creditors.
Here are some examples:
Irrevocable trusts are typical trusts in which an individual (the “settlor” or “grantor”) places assets that are managed by a named trustee on behalf of a beneficiary. With an irrevocable trust, the grantor relinquishes ownership rights over the assets. Once the property has been transferred to the trust, the trust itself is considered the owner. This provides a layer of protection against claims from creditors.
In addition, if the trust incorporates a “sprendthrift provision,” the trustee generally cannot be obligated to liquidate trust assets to satisfy a creditor judgment against a trust beneficiary. But this is only effective if the trust planning is completed prior to a creditor claim.
It is important to remember that the trust must be irrevocable. Standard revocable trusts can be established to avoid the probate process, but do not offer asset-protection benefits. The fact that irrevocable trusts have a proven track record within the U.S. court system is important to those looking for asset protection.
An offshore trust is established when an investor transfers assets to a foreign trustee who is not subject to the jurisdiction of U.S. laws and courts. The premise is that assets held in these trusts are protected from a civil judgment occurring within the U.S. court system.
There may be limitations, however, in cases where the grantor of the trust assets retains a level of control over those assets (for example, in cases where the trust is considered self-settled). There have been several cases where U.S. courts have issued a repatriation order, in which the defendant is ordered to bring assets back to the United States or be held in contempt for failing to do so.
To avoid a self-settled trust designation, the settlor must generally relinquish all control to a foreign trustee. That option may not be appealing to some investors. Investors also need to understand that these trusts are typically complex and expensive to establish, although they may act to deter potential creditors.
Domestic asset protection trusts
Domestic asset protection trusts are similar to offshore trusts, but may only be established in states that have legislation allowing these trusts. There are currently 15 states that offer domestic asset protection trusts. Domestic asset protection trusts provide greater protection against creditors.
Typically, the settlor and the beneficiary are the same person; that is, the person who creates and funds the trusts also benefits from the assets. It’s important to note that because state laws creating these trusts are relatively new, there is not much existing case law available to provide precedent of their effectiveness as asset protection vehicles.
Asset protection is a key part of estate planning. Particularly when working with complex legal structures, it is important to meet with a financial professional or legal expert who understands your goals and can provide guidance on choosing a specific trust. For more detailed information on asset protection strategies, read Putnam’s investor education piece, “Asset protection: Basic principles and strategies for safeguarding your wealth.”