Whether your trust assets are protected from creditors depends on three things:
- The type of trust
- The person against whom the creditor has a claim
- The nature of the creditor claim
Only certain types of trusts and trust provisions confer asset protection, and even then, the protection may be subject to certain exceptions.
Read on to learn the ins and outs of trust asset protection.
Trust Asset Protection At A Glance
| Settlor's Creditors | Beneficiary's Creditors | |
|---|---|---|
| Revocable living trust | No | No* |
| Revocable living trust with spendthrift provisions | No | Yes |
| Irrevocable trust | Limited | No* |
| Irrevocable trust with spendthrift provisions | Yes | Yes |
* Certain states limit by default the percent to which a creditor may attach a claim in the trust assets of a beneficiary, even if the trust is not a spendthrift trust
Which types of trust offer asset protection?
There are two major types of trusts: revocable trusts and irrevocable trusts.
Revocable trusts are trusts that may be changed or cancelled by the Settlor (e.g., the Trustmaker) after they are created. Irrevocable trusts are trusts that cannot be changed or cancelled after they are created.
In both a revocable living trust and an irrevocable living trust, trust assets are retitled from the Settlor’s name to the trust, a process known as funding the trust.
Since the Settlor of a revocable living trust continues to retain the ability to modify the trust, the trust assets are considered part of the Settlor’s estate. This means that the trust assets are treated as if the Settlor owned the assets directly, which makes the trust assets subject to claims of the Settlor’s creditors (Uniform Trust Code, SS 505(a)(1)).
Irrevocable trusts, on the other hand, put assets outside the control of the Settlor, which may in some cases also put them beyond the reach of the Settlor’s creditors. Under the Uniform Trust Code, the creditor of a Settlor to an irrevocable trust may only reach the maximum amount that can be distributed to or for the Settlor’s benefit (Uniform Trust Code, SS 505(a)(2)). In most cases, this maximum amount is less than the total value of all property in the trust that would be subject to the claim if the trust were a revocable trust. However, the ‘standard’ irrevocable trust with the Settlor as a beneficiary does not offer absolute asset protection from creditors. For this reason, individuals who have a lifestyle or career that makes them high targets for lawsuits may turn to a special type of irrevocable trust, called an asset protection trust, to move assets out of reach of potential creditors, lawsuits, and judgments.
In an asset protection trust model, the trust terms dictate that if the Settlor becomes subject to a lawsuit or likely to lose a creditor judgment, the Trustee is prevented from distributing any of the assets or income of the trust to the Settlor. This “spendthrift” provision makes the trust assets and income inaccessible to the other party. Not all states allow the creation of Domestic Asset Protection Trusts, and therefore these types of trusts are often created in states that have trust-friendly laws like Delaware, Nevada, South Dakota, and Tennessee.
Does a trust protect assets from a trust beneficiary’s creditors?
Ordinarily, the creditors of a person in debt may attach claims to money or assets that person receives or is due to receive as a gift in someone else’s estate plan just as they could with any other asset (Uniform Trust Code, SS 501).
To prevent this from happening, some trusts contain terms called spendthrift provisions that restrict the beneficiary from voluntarily or involuntarily transferring his or her interest in the trust.
Claims for Which Trusts Do Not Offer Asset Protection
Even if a trust has spendthrift provisions protecting against most creditor claims, it may not be able to protect against the following types of claims:
- A beneficiary’s child, spouse, or former spouse who has a judgment or court order against the beneficiary for support or maintenance
- A creditor who has provided services for the protection of a beneficiary’s interest in the trust
- A claim by the State or the United States federal government (i.e., the IRS), to the extent a relevant state or federal statute authorizes the claim
How to Protect Assets in a Trust
Protecting trust assets from your creditors as the Settlor through an irrevocable trust does not need to be complicated.
Although there is no legal requirement that you make your irrevocable trust with an attorney, you should nonetheless seek guidance from an estate planning attorney in drafting and managing your irrevocable trust, because you will be highly limited in your ability to make changes to the irrevocable trust down the road. If you plan to go this route, check out our tips on what to look for in an estate planning attorney and how to find one.
By contrast, protecting trust assets from one or more beneficiary’s creditors in a revocable living trust is easy and safe to do. Instead of making the gift to the beneficiary outright, you specify in your Trust Agreement that the gift is to be made through a spendthrift trust. The inclusion of the words “spendthrift trust” is sufficient to convey that the trust assets may not be voluntarily or involuntarily pledged or assigned by the beneficiary, thereby putting them out of the reach of creditors.
When you create your revocable living trust with Just In Case Estates, we give you the option to make your gifts subject to spendthrift provisions in order to better protect the trust assets from your beneficiaries’ creditors.
Creating your trust with Just In Case Estates is free to get started, and you’ll pay just $348 for an individual trust and $448 for a couple’s trust.
