Using a Trust to Protect Assets from Creditors and Lawsuits

How to Protect What You’ve Built

Wealthy business owners aren’t the only ones who need asset protection. If you have any property or savings, they can be vulnerable to creditors, lawsuits, or other financial threats. Setting up the right trust in advance can protect your assets without breaking the law.

Let’s review what is an asset protection trust, the most effective types, and when they can or cannot be used.

What Is a Trust?

A trust is a legal arrangement. The grantor transfers assets into the trust, which is managed by the designated trustee. The trust is structured for the benefit of you and your beneficiaries.

Trusts can serve many goals. They are commonly used for estate planning, tax efficiency, privacy, and asset protection. Let’s go over how to use a trust to protect your assets from creditors and lawsuits, and why that might be a good idea in the first place.

Why You Might Need Asset Protection

Personal liability exposure

Professionals are often the targets of lawsuits. For example, doctors, business owners, and landlords often find plaintiffs at their doors. Losing a lawsuit could mean losing thousands, or even over a million, dollars. The lawsuit could take the value out of your owned assets.

Debt or financial risk

Creditors can seize personal assets to satisfy judgments in their favor. This means that if you take out any loans from other people or companies, your assets are at risk of being seized if you fail to make loan payments or repayments on time.

Divorce, family disputes, and confusion

If you don’t have a separate trust for particular assets, there may be confusion later down the line when it’s time for asset distribution. Your family members or ex-spouses may dispute certain inheritances because of confusion and divorce.

Using a trust can help you protect inheritances or separate property from division. However, note that your ex-spouse may be legally entitled to alimony or child support. Alimony does not generally continue after death, but sometimes the court may order the estate to continue paying alimony regardless. This depends on the agreement.

Business ownership

You may want to separate your personal wealth from business liability. A trust can be used to facilitate asset protection for businesses.

Protecting heirs

If you want your assets to actually pass on to your heirs safely, then a trust can ensure that. Creditors otherwise might collect debt from your estate, which means draining it until the debt is satisfied and leaving less (or even nothing) for your loved ones.

Revocable vs. Irrevocable Trusts for Asset Protection

Revocable Trust

A revocable trust is also known as a living trust. It can be amended or terminated at any time by the grantor during their lifetime, providing more control and flexibility. The main benefit of a revocable trust is that it can give privacy, protecting inheritances from the public probate process.

However, a revocable trust cannot shield its assets from creditors or plaintiffs. You, the grantor, still legally own all of the assets while alive.

Irrevocable Trust

An irrevocable trust lets you transfer ownership of assets out of your estate and into the trust. Irrevocable trusts cannot be easily modified without a court order or beneficiary consent.

One major advantage of irrevocable trusts is that creditors generally cannot access them for any assets you may owe. You do not technically control these assets directly.

Important: Only irrevocable trusts offer true asset protection, and they have to be used properly.

Types of Trusts That Protect Assets

Irrevocable trusts come in many types. Depending on your situation and which state you live in, you have different options.

Domestic Asset Protection Trust (DAPT)

A DAPT lets you be both the grantor of the trust and the beneficiary, while also shielding assets from creditors. It is considered self-settled.

DAPTs are only legal in certain U.S. states, such as Alaska, Delaware, Hawaii, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming. This can change, so check the current laws of your state.

DAPTs offer strong privacy and asset shielding, while being more flexible than other irrevocable trusts. However, they have state-specific rules, and are currently only allowed in seventeen states.

Irrevocable Life Insurance Trust (ILIT)

An ILIT lets you keep life insurance proceeds out of your taxable estate. You can have the trust own the life insurance policy.

ILITs can protect your life insurance funds from creditors, ensuring that the death benefit goes directly to the designated beneficiaries. If you are worried about estate taxes, ILITs can also help you avoid unnecessary estate taxes up to 40%.

Ethos offers affordable, easy-to-manage life insurance that can be integrated with an ILIT.

Offshore Asset Protection Trust

Offshore asset protection strategies involve creating a trust in a jurisdiction that is outside of the U.S., such as Cook Islands. The assets offer robust protection because they are often beyond the reach of U.S. courts. If a creditor is chasing the asset, foreign lawsuits may need to be filed, which is a lengthy and expensive process that many creditors do not find worth it.

However, offshore trusts are complex, costly, and require specialized legal guidance. Attorney counsel is needed.

Spendthrift Trust

A spendthrift trust protects a beneficiary’s inheritance from their creditors (or poor spending habits). Spendthrift trusts are common for dependents and family members who face financial challenges or have poor financial habits. These trusts can be structured so that the beneficiary can only access the trust under certain conditions for certain purposes, as the beneficiary doesn’t own the trust funds outright.

For example, a spendthrift trust might only give the funds out to the beneficiary on a monthly basis instead of as a lump sum.

Qualified Personal Residence Trust (QPRT)

A QPRT can protect your home specifically from creditors while reducing estate tax exposure. You still retain the right to live in the property for a set period before it gets transferred to your designated heirs.

How an Asset Protection Trust Works

To have an asset protected by an asset protection trust, you (the grantor) need to transfer that asset into the trust.

The trustee is the person who will manage the trust. Trustees can be someone you trust, like a family member, or a professional. They will carry out your wishes regarding the trust.

You may still benefit from the trust depending on what type of trust you have established.

Assets you transfer into an irrevocable trust are no longer legally owned by you. That means that creditors or claimants can’t asset these assets, except under special circumstances.

Upon your death, the assets will be transferred privately to your beneficiaries, bypassing the probate process.

Exceptions

APTs don’t work for protection against every type of financial obligation. For example, the IRS and government agencies can bypass some irrevocable trusts. Court-ordered child support and alimony payments can also go through.

Crucial warning: If you transfer assets after a lawsuit or claim has already begun, this can be seen as fraudulent conveyance. This would make the trust invalid.

Legal and Ethical Considerations

Fraudulent conveyance concerns

Asset protection is legal when done before a claim arises. It cannot be done if it is seen as fraudulent conveyance, which is the illegal transfer away of funds in order to dodge or hinder creditors.

APTs should not be a way to hide assets from active claims or evade debts. Note that courts can also “look back” several years to determine your intent, so it is best to act early and transparently.

Pro tip: Work with a qualified estate planning attorney who is familiar with asset protection. Use trusted online services like LegalZoom to ensure your trust complies with state and federal law.

Additional Benefits of Asset Protection Trusts

Privacy

Trusts can keep your assets and beneficiary details outside of the public record. This is useful because the probate process is the standard asset distribution process, and its records can be accessed by the public.

Estate tax efficiency

Estate taxes occur on your taxable estate. If your estate exceeds the tax threshold, then estate taxes would need to be paid on the excess amount.

Family security

APTs can help you potentially shield your assets from divorce, bankruptcy, or creditor claims, for the sake of your loved ones and family members. If there are any financial disasters or disputes that impact your inheritance for your family, a trust structured properly in advance can prevent these problems from hurting them.

Continuity

Are you thinking about legacy planning? You can ensure your wealth passes smoothly to future generations using special trusts, though asset protection trusts may not be the best option. Consider dynasty trusts if you want to preserve generational wealth, or charitable trusts for philanthropic goals.

Combining a Trust with Other Asset Protection Tools

Business Entities

Business assets can be separated from personal assets through LLCs or corporations. These processes need to be legally and carefully structured to avoid problems down the line. Consult with an attorney for business asset protection.

Insurance Coverage

Insurance can be paired with trusts for stronger liability protection. Consider umbrella and liability insurance policies.

Life insurance can provide your beneficiaries with fast, protected funds. Consider Ethos for affordable life insurance to complement asset protection plans.

Homestead Exemptions

A homestead exemption can protect primary residences when applicable. Essentially it lowers the value of the property for tax purposes. However, to qualify for homestead exemptions you will have to look up your local state laws.

Retirement Accounts

Many retirement accounts, like IRAs, have strong legal protection already. It is highly recommended to use the tax advantages and financial benefits that come with retirement accounts.

Common Mistakes to Avoid

• Waiting until after a lawsuit or creditor issue to act
• Using a revocable trust
• Naming yourself as trustee of an irrevocable trust
• Choosing the wrong jurisdiction, not adhering to state laws, or being non-compliant with regulations
• Failing to update the trust as laws or circumstances change
• Not funding the trust

How to Set Up a Trust for Asset Protection

To set up an asset protection trust, you have to first identify what you want to protect. This can be anything such as property, savings, investments, or business interests.

Then, decide on the right type of trust: domestic or offshore, individual or family. The type of trust needs to be properly structured and legal to avoid serious ramifications. Choose a reliable trustee, and consider consulting a legal professional to establish a complex trust that aligns with your needs (while staying compliant).

You can draft the trust document using an attorney or an online trust creation platform like LegalZoom.

Don’t forget to transfer ownership of selected assets into the trust. Be aware of the restrictions if you’re transferring them into an irrevocable trust–it will be very difficult to modify the trust afterwards.

Remember to maintain compliance. Keep records and follow all financial reporting and tax rules.

Conclusion: Protect Your Future Before You Need To

Asset protection is best done–and oftentimes only legal when done–early. Secure your hard-earned assets by establishing a properly structured irrevocable trust.

A trusted online trust creation platform like LegalZoom is much more affordable than the traditional attorney route. We recommend their optional attorney services if you have any asset protection goals or special tax concerns.