Most people are familiar with common estate planning tools, such as a will or revocable living trust. A living trust will make sure a decedent’s assets are passed to their chosen beneficiaries upon death and not to the government or creditors. Occasionally a client will ask about setting up trust to protect assets from creditors. Although we cannot provide legal advice, generally speaking a trust’s main purpose is not to avoid creditors. In particular, people usually set up a living trust to avoid probate of their estate in case of death. In other words, a trust is a legal instrument used to transfer ownership of an asset into the care of another person (trustee). The trustee can then administer the estate for the benefit of another person (beneficiary). Read on to learn more about different types of trusts and whether setting up trust to protect assets from creditors is something you should consider.
Setting Up Trust to Protect Assets From Creditors Requires Irrevocable Trust
An irrevocable trust is a special type of living trust that protects trust assets from creditors. Setting up a trust to protect assets from creditors through an irrevocable trust, however, has many downsides. These downsides could diminish the benefit of protection against creditors that an irrevocable trust offers. First, once an irrevocable trust is created, the grantor no longer legally owns the assets used to fund it. Furthermore, the grantor also loses the right to dictate how the assets are to be distributed. This is a huge drawback to setting up an irrevocable trust. Once an irrevocable trust has been signed and funded, the terms of the trust are set by law. The trust maker surrenders their authority over those assets. Consequently, changes to the trust cannot be made 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 that is placed in it. The trust maker fully surrenders ownership of their assets when they are re-titled in the name of the trust. 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.
As a result of the change of ownership, future creditors of the trust maker cannot satisfy a judgment against the grantor by seizing irrevocable trust assets. Keep in mind, however, if a grantor places property into an irrevocable trust for the purpose of defrauding his/her creditors, a court can undo the transfer.
Because the irrevocable trust is a separate entity, there are other disadvantages. The irrevocable trust is subject to annual income taxes and/or gift taxes. Taxes are paid using the assets of the trust. The tax rate for irrevocable trusts is normally higher than the rates for people.
Irrevocable trusts are commonly used to remove the value of property from a person’s estate. Once removed, this property cannot be taxed. Other forms of creditor asset protection include retirement accounts, purchasing annuities, investing in a primary residence, and setting up a limited liability corporation. For the most part, setting up an irrevocable living trust solely to avoid creditors may end up being more costly. Furthermore, setting up trust to protect assets from creditors could create more problems than the benefits it may offer.
Spendthrift Trust Protects Against Beneficiary’s Creditors
On the other hand, a spendthrift trust limits the beneficiary’s creditors from seizing trust assets. A spendthrift trust is created by a grantor who wants to leave property to a beneficiary, but is concerned that the beneficiary may not use it properly. The grantor can place restrictions on the beneficiary’s access to the trust’s principal. These restrictions include any promises the beneficiary may make to any potential creditors. If a beneficiary is unable to get access to the trust funds, his/her creditors will be unable to do so as well. A creditor however may have the right to get access to income or principal once distributed to the beneficiary.
Revocable Living Trust Does Not Protect Against Creditors
A revocable living trust is usually created to avoid probate. This type of trust is a written legal document in which a person’s assets are placed into a trust for the benefit of the person during his/her lifetime. Upon death, trust assets are transferred to designated beneficiaries. A revocable living trust is subject to creditor claims. Though the trust is a legal entity, the grantor is treated as the owner of the trust assets.
In conclusion, setting up a trust to protect assets against creditors may not be as great an idea as one would initially think. When you have an irrevocable trust, the trust maker has no power to revoke, rescind or amend the trust. They do not keep any rights directly or indirectly to reclaim property in the trust. In effect, they lose control of their assets and their estate.
If you still want to explore creating an irrevocable living trust, we would recommend you contact a estate planning lawyer. Irrevocable living trusts are complicated as well as very expensive. You may also want to contact a tax specialist as you will need professional help complying with the tax issues surrounding having an irrevocable living trust. On the other hand, it you simply want to set up 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.