Pros and Cons of an Asset Protection Trust

Pros and Cons of an Asset Protection Trust

by Belle Wong, J.D., October 2018

One powerful estate planning tool is the asset protection trust. As its name suggests, an asset protection trust helps keep your assets out of reach of creditors. However, such a trust needs to be properly established in order to provide the protection you're looking for.

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Asset Protection in a Revocable Living Trust

Generally speaking, if asset protection is your goal, a revocable living trust is not the proper vehicle for your purposes. The settlor, or person who creates the trust, essentially retains control and ownership of the trust's assets, meaning they can remove assets from the trust or change the trust terms at any time, while the trust itself simply holds title to the assets. In the event a creditor wins a lawsuit against the settlor, the court can order the payout of trust assets in settlement of the creditor's claim.

Although revocable trusts do not offer asset protection, they have other benefits when it comes to estate planning. For example, such trusts can be helpful in avoiding probate fees when the settlor passes.

Asset Protection in an Irrevocable Trust

In order to properly protect your assets, you need an irrevocable trust. As its name suggests, once such a trust is created, you cannot revoke it yourself by changing its terms, nor do you have control over the trust's assets.

Instead, the trust's assets are in the control of the trustee, or person assigned to manage the trust, and any changes or distributions are at the trustee's discretion. If a creditor files a lawsuit against you, the assets in the trust will likely not be considered yours, so even if the creditor wins judgment against you, the chances are much better that the assets residing in the irrevocable trust will be protected.

Domestic Asset Protection Trust

There are two kinds of irrevocable trusts that work as asset protection vehicles: domestic asset protection trusts and foreign asset protection trusts. A domestic asset protection trust can be established within the U.S. in any of the states that provide legislation permitting the creation of such trusts. Not all states provide for asset protection trusts, so it's important that you consult with an estate planning adviser or online service provider to determine which state, if any, is best to set up such a trust. However, as these trusts have become more common, more and more states have come to recognize the legal status of such trusts.

Note that it is less costly to set up an asset protection trust in the U.S. than it is to create a foreign asset protection trust. Because these trusts are fairly new, the case law concerning their treatment is constantly evolving, which adds a level of uncertainty to their ability to properly protect assets. Most states have a limitation period during which assets transferred into such a trust remain vulnerable to creditors.

Foreign Asset Protection Trust

The foreign asset protection trust, also known as an offshore trust, provides more effective protection for your assets. Such trusts are established in jurisdictions outside of the U.S., such as the Cook Islands, which provide more stringent protection for trusts and their assets. Because your trust is in a foreign jurisdiction, it's governed by the laws of that jurisdiction rather than by U.S. laws.

Although they are usually more costly than their domestic counterparts, foreign asset protection trusts generally have more stringent privacy measures, making it harder for others to learn the trust terms and assets. Another benefit is that jurisdictions that promote themselves as offshore trust havens usually do not enforce U.S. judgments against assets of trusts formed in their jurisdiction.

In many cases, assets of a foreign asset protection trust are held in an offshore account. While this provides more protection from a U.S. court-ordered seizure of assets, it does expose the assets to potential economic and political risks associated with the jurisdiction in which the offshore account is held.

Medicaid Asset Protection Trust

While one of the primary purposes of an asset protection trust is to protect the settlor's assets from creditors' claims, such a trust can also be used to help make you eligible for Medicaid by reducing the assets in your name. If you are planning to set up a trust for this purpose, it's important to consult with an adviser with experience in this area, as not every trust can help you comply with Medicaid's eligibility requirements.

An asset protection trust can be a vital estate planning tool. Because it's crucial for such a trust to be set up properly, consult with an adviser with expertise in asset protection matters.