Should You Use a Trust to Protect Your Assets from Creditors?

Most people are familiar with common estate planning tools like wills and revocable living trusts. Typically, clients choose living trusts to ensure the courts pass on their assets to their chosen beneficiaries upon death. Additionally, they often choose living trusts to help their successors avoid probating their estate. Occasionally, however, clients are more concerned with ensuring the court does not pass on their assets to the government or creditors. Although we cannot provide legal advice, we do encourage our clients to educate themselves about different types of trusts and whether setting up a trust to protect their assets from creditors is a beneficial option.

Protecting Assets From Creditors Requires an Irrevocable Trust

A trust is a legal instrument that transfers ownership of an asset to another person, or trustee. With this ownership, a trustee can administer an estate for the benefit of another person, or a beneficiary. Put simply, a trustee transfers assets to beneficiaries upon the trust maker’s death. Therefore, revocable living trusts are subject to creditor claims. On the other hand, however, an irrevocable trust is a special type of living trust that protects trust assets from creditors. 

How Irrevocable Trusts Protect Assets from Creditors

Since irrevocable trusts result in a changed ownership of assets, future creditors of a trust maker cannot satisfy a judgment against the grantor by seizing these trust assets. Keep in mind, however, if a grantor places property into an irrevocable trust for the purpose of defrauding creditors, the court can undo the transfer.

Additionally, trust makers often use irrevocable trusts to remove the value of property from their estate. Once removed, this property cannot be taxed. However, for the most part, setting up an irrevocable living trust solely to avoid creditors may end up being extremely costly. Plus, it could create more problems than it solves.

Downsides of Irrevocable Trusts

First, after creating an irrevocable trust, the grantor no longer legally owns the assets used to fund it. Therefore, the grantor loses the right to control the distribution of their assets. In other words, after signing and funding an irrevocable trust, the terms of the trust are set by law, and the trust maker surrenders all authority over their assets. Consequently, they can no longer make changes to the trust unless the trust maker(s) and all of its possible beneficiaries agree to those changes.

With an irrevocable trust, the trust maker loses control over any asset they place in it. The trust maker fully surrenders ownership of their assets when they are re-titled in the name of the trust. Thus, the irrevocable trust is completely out of the trust maker’s hands and can be revoked only by court order under certain circumstances or with the consent of all the beneficiaries.

Additionally, irrevocable trusts come with other disadvantages due to being a separate entity. For example, the irrevocable trust is subject to annual income taxes and/or gift taxes, which trustees pay using the trust’s assets. Plus, the tax rate for irrevocable trusts is typically very high.

Other Ways to Protect Assets From Creditors

Luckily, irrevocable trusts aren’t the only option for protecting assets from creditors. For example, other forms of creditor asset protection include:

• establishing retirement accounts;
• purchasing annuities;
• investing in a primary residence;
• setting up a limited liability corporation; and
• creating a spendthrift trust

Spendthrift Trusts

Spendthrift trusts limit the beneficiary’s creditors from seizing trust assets. Therefore, grantors may create a spendthrift trust to leave property to a beneficiary they are concerned may not use it properly. With this trust, the grantor can place restrictions on the beneficiary’s access to the principal. For example, these restrictions include any promises the beneficiary may make to potential creditors. Then, if a beneficiary is unable to access the trust funds, their creditors may not do so either. That said, a creditor may have the right to access the income or principal once distributed to the beneficiary.

What to Consider Before Setting Up Your Trust

In conclusion, setting up a trust to protect assets against creditors may not be as great an idea as one would initially think. With an irrevocable trust, the trust maker has no power to revoke, rescind, or amend the trust. They do not keep any rights to reclaim property in the trust and, in effect, lose control of their assets and estate.

Therefore, if you are considering creating an irrevocable living trust, we recommend contacting an estate planning lawyer. Irrevocable living trusts are complicated and very expensive. In fact, you may also want to contact a tax specialist. Chances are, you will require professional help complying with the tax issues of irrevocable living trusts.

On the other hand, if you want to stick with a revocable living trust so your estate will avoid probate, contact A People’s Choice. We can help you create a revocable living trust for a fraction of what an attorney would charge. Call us for more information at 800-747-2780.