Trusts are often established to achieve estate planning goals, including reducing taxes. But they can also help protect assets from creditors, former business partners, ex-spouses and “spendthrift” children. As this article explains, a trust must be irrevocable. It may also make sense to give trustees full discretion over whether and when to make distributions.
A trust can be a mighty financial fortress
You may think of trusts as estate planning tools — vehicles for reducing taxes after your death. While trusts can certainly fill that role, they’re also useful for protecting assets, both now and later. Creditors, former business partners, ex-spouses, “spendthrift” children, and taxes can all pose risks. Here’s how trusts defend against asset protection challenges.
Tell creditors “hands off”
To protect assets, your trust must own them and be irrevocable. This means that you, as the grantor, generally can’t modify or terminate the trust after it has been established. (A “revocable trust,” on the other hand, allows the grantor to make modifications.) Once you transfer assets into an irrevocable trust, you’ve effectively removed your rights of ownership to the assets. Because the property is no longer yours, it’s unavailable to satisfy claims against you.
It’s important to note that placing assets in a trust won’t allow you to sidestep responsibility for debts or claims that are outstanding at the time you fund the trust. There may also be a substantial “look-back” period that could eliminate the protection your trust would otherwise provide.
Build a fence
If you’re concerned about what will happen to your assets after they pass to the next generation, you may want to consider the defensive features of a “spendthrift” trust. Despite the name, a spendthrift trust does more than protect your heirs from themselves. It can protect your family’s assets against dishonest business partners and unscrupulous creditors. It also can protect loved ones in the event of relationship changes. For example, if your son divorces, his spouse generally won’t be able to claim a share of the trust property in the divorce settlement.
Several trust types can be designated a spendthrift trust — you just need to add a spendthrift clause to the trust document. Such a clause restricts a beneficiary’s ability to assign or transfer his or her interests in the trust, and it restricts the rights of creditors to reach the trust assets. But a spendthrift trust won’t defend against claims from your own creditors unless you relinquish any interest in the trust assets. And, depending on applicable law, it’s possible for government agencies to reach trust assets so, for example, they can collect on tax obligations.
Trustees play a role in keeping your trust safe. If a trustee is required to make distributions for a beneficiary’s support, a court may rule that a creditor can reach trust assets to satisfy support-related debts. So, for increased protection, consider giving your trustee full discretion over whether and when to make distributions. You’ll need to balance the potentially competing objectives of having the access you want and preventing creditors and others from having access.
Make asset protection a priority
If securing your assets is a priority — and it should be — talk to your financial advisor about whether a trust can provide the protection you need. There may also be other ways to shelter wealth — for example, maximizing your use of qualified retirement plans. Another option to protect against creditors is to buy an umbrella insurance policy, which provides liability coverage beyond what your auto or homeowners’ policies cover.