What is an asset protection trust?
Functionally an asset protection trust is similar to any other type of trust. Like other trusts, an asset protection trust requires the following elements: a grantor (the person establishing the trust); the trustee (the person responsible for managing the trust); and trust assets held for the beneficiary. The trustee must manage the trust, according to the trust agreement that outlines under what conditions the trust assets should pass to a beneficiary.
Asset protection trusts function in a similar fashion to other types of trusts; however, an asset protection trust offer heightened protections concerning the protection of trust assets from creditor claims. When comparing an asset protection trust with another form of trusts, asset protection trusts shield trust assets against claims by creditors.
Other trusts, such as a living trust, often used to avoid probate in estate planning, do not normally offer this type of protection. However, asset protection trusts provide a form of protection against creditor claims levied against the grantor or beneficiary.
For example, assets placed in an asset protection trust for your children would protect these trust assets from your children's creditors, in that they could not be seized as part of legal proceedings. However, if a grantor establishes a trust naming himself as the beneficiary (a self-settled trust) the law is less clear as to the level of protection offered against claims levied by the grantor/beneficiary’s creditors.
Asset protection trusts come in two forms: (1) third-party trusts; and (2) self-settled trusts. A third party trust is similar in the form of trusts that most people are familiar with in that they are set up by one party for the benefit of another. A self-settled trust differs in that one party creates it for their own benefit.
For example, a self-settled trust, takes the grantor’s assets, places them in trust and then contains stipulations as to when and under what conditions the grantor/beneficiary may receive the assets. Unlike a bank account or investment account, which may be seized by creditors, an asset protection trust provides a level of protection against creditor claims. However, this protection comes at the expense of more restriction when compared to other vehicles for holding assets.
Special Rules Concerning Asset Protection Trusts
An asset protection trust provides significant protection for trust assets; however this protection comes at the cost of a number of restrictions regarding how the trust is managed and in some cases where the trust can be established and maintained.
Some States recognize asset protection trusts in some form. However, it is important to note that these laws are subject to change and differ as to the requirements placed on asset protection trusts with some jurisdictions placing limits on when creditor protections come into effect. For example, some jurisdictions place a two-year period after funding of the Trust for creditor protections to take effect.
Besides some jurisdictions within the United States, some offshore locations also allow individuals to establish asset protection trusts. Offshore asset protection trusts have been used for many years to protect assets.
However, this type of strategy comes with a caveat. Recent changes in IRS regulations and the inherent risks involved with international financial transactions have placed some doubt over the viability of offshore asset protection trusts.
As with any estate planning technique, an asset protection trust contains some restrictions that may influence the decision to use this type of financial planning vehicle. These restrictions include the fact that asset protection trusts are irrevocable or unchangeable.
Restricting the ability to to revoke or change the terms of an asset protection trust is based on the idea that a trust beneficiary must surrender some level of control over these assets in exchange for protection from creditors. Further to avoid the risk of abuse of this protection from creditor claims a trustee must administer the trust, and the trustee must be a resident of the jurisdiction in which the trust is formed.
Additionally, an asset protection trust must contain a spendthrift clause, restricting the transferability of a beneficiary’s interests in the trust property. This restriction prevents beneficiaries from using an asset protection trust as a proxy bank account rather than a trust whose purpose is to preserve assets for the future use by a beneficiary.
Given these restrictions, electing to use an asset protection trust requires additional considerations as to how the trust assets will be utilized in the future and whether the requirements on the location of the trustee can be satisfied.
An asset protection trust attorney can provide an evaluation as to whether this structure is an appropriate asset management vehicle. Counsel experienced in asset protection trusts can also provide advice regarding the tax implications and financial impact of this form of trust. Given the amount of trust arrangements available, discussing these options with counsel experienced in wealth management and asset protection is an important first step in this decision-making process.
What is an asset protection trust?