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Can a Trust Protect My Assets from Creditors?

There is a common misconception that putting your assets into a trust can always shield them from lawsuits and your creditors.  That is not necessarily true.  That is not to say that a trust, along with the right insurance coverage, cannot help to protect assets.  In this article, we will discuss different types of trusts and address how one may go about protecting their assets.  

What Is a Trust?

A trust is a legal entity that is funded with assets from the trust maker, the grantor, and places those assets into the care of a trustee for the benefit of one or more beneficiaries.  Living trusts, which are made during one’s life, come in two main forms: revocable and irrevocable.  While these two types of trusts have their differences, they are similar in that they retain assets from the grantor and distribute them to the named beneficiaries.

Trusts are often used to distribute assets to heirs in a way that bypasses probate, but there is a common misconception that these trusts can always shield assets from lawsuits and creditors.  While that is often not the case, there are several benefits that do make trusts useful.  

While some trusts are better equipped to protect assets, a revocable living trust will not offer the grantor these types of protections, but it does carry many other benefits the grantor may desire.  These benefits include asset consolidation and assurance that those assets will go where you want them to upon passing.

Different Types of Trusts

The two main types of trusts we will address are revocable trusts and irrevocable trusts.  A revocable trust is one that can be modified or terminated by the grantor at any time while an irrevocable trust cannot be modified or terminated by the grantor once it is created and funded.  In New Jersey, there are narrow instances where modifications to an irrevocable trust are allowed, but never solely at the discretion of the grantor and never if the modification upsets the main purpose of the trust.

Revocable living trusts are not the kind of trusts that can shield assets from the creditors of the grantor on their own. That is not to say there are not ample benefits that revocable trusts can provide. These trusts can help your beneficiaries avoid probate, there is a lower investment to set these trusts up, and they allow you the flexibility of moving assets in and out of the trust during your lifetime.  

Irrevocable trusts are usually effective at shielding assets from creditors, but many types of irrevocable trusts require the grantor to relinquish control and ownership of the asset upon transferring the asset to the trust.  The trade-off here is that the asset gains protection from creditors, but the grantor no longer can exert control over the asset.  The grantor essentially forgoes control over the asset for the rest of their life, which is usually not something someone wants to do unless it is absolutely necessary.  Irrevocable trusts also require a larger investment to create, which can be a deterrence for some.  

For those who are willing to give up control and endure the high setup and ongoing costs of creating a trust to protect their own assets during their lifetime, a domestic asset protection trust may be an option.  This type of estate planning is often reserved for those with high net worths that are almost certain to be sued in their lifetime, such as surgeons. 

Which Trusts Can Protect My Assets from Creditors?

When it comes to protecting assets from creditors, there is a misconception that revocable living trusts can always provide that protection.  Revocable living trusts offer great flexibility but do not offer protection from creditors on their own.  A grantor can also invest in asset protection insurance to help shield their revocable trust assets, but the trust itself does not offer these protections specifically.  

Irrevocable trusts provide stronger protection, but at the steep cost of forfeiting your ability to use or control the asset.  Many people who would like to gain this protection for their assets realize that forfeiting the asset renders the protection useless.

Domestic Asset Protection Trusts

A domestic asset protection trust (DAPT) can offer the desired protection but is often very expensive to create and will need to be created in a state with favorable laws.  DAPTs allow the grantor to be named a beneficiary, which makes it a distinct type of irrevocable trust. While the grantor may not have total control of the asset, the grantor can get the asset back.

The protection offered by DAPTs and other irrevocable trusts is strong but also requires a heftier investment, both monetarily and in terms of relinquishing control.  If you believe a revocable living trust to be more fitting for you, then we recommend speaking with an estate planning attorney at Rosenblum Law.

Pros and Cons of DAPTs

A domestic asset protection trust is an irrevocable, self-funded trust that allows the grantor to be a named beneficiary.  As a type of irrevocable trust, DAPTs are capable of shielding assets.  The grantor must fund the trust and can do so with assets such as real estate, cash, LLCs, and securities.

A DAPT must also include a spendthrift provision.  A spendthrift provision is a provision that can be included in a trust and outlines terms for how the assets are to be distributed.  Spendthrift provisions are often used to release the inheritance in increments to help the beneficiary better manage the assets.  

The catch with DAPTs is that they can be problematic and expensive to create.  In addition to being very expensive to set up, they also cannot be created in New Jersey.  States that offer DAPTs include Connecticut and Delaware.  New Jersey residents can still create DAPTs, but will need to do so in a state that allows their creation.  The grantor will then have to name a trustee who is a resident of that state. Since these trusts are not created in New Jersey, the grantor cannot name themself or another New Jersey resident as the trustee.  The grantor would have to find a trustee from the appropriate state, and often this trustee will be a corporate entity that will need to be paid to administer the trust for the entirety of its existence.

As mentioned above, these types of trusts are usually created by people like surgeons.  That is to say, professionals who make a lot of money and are likely to be sued at some point.  For someone in this situation, it could be worth the money and hassle of creating a DAPT in order to protect assets from an almost inevitable challenge.

Why Do Different Trusts Offer Different Protections?

Different types of trusts offer different protections because their inherent characteristics lend themselves to certain protections.  A revocable living trust affords the grantor tons of flexibility.  Since the grantor continues to control the asset, the asset remains within reach of the grantor’s creditors.  

Irrevocable trusts give the grantor no flexibility and strip them of control over the asset once the asset is placed in the trust.  This greater sacrifice in turn grants better protection because it essentially takes the asset away from the grantor and therefore takes it out of reach of the creditor.  

DAPTs are a unique case.  They are a newer legal tool and can only be created in 20 states, New Jersey not being one of them.  Here, the grantor is essentially punting the asset to themself down the line. The expense of creation and potential temporary loss of control create a higher barrier to entry, thus justifying the better protection.

Which Trust Is Right for Me?

There is no magical trust that is accessible, affordable, allows one to retain their assets, and shields the assets from creditors or lawsuits.  We discussed a few types of trusts and highlighted the pros and cons for each.

Irrevocable trusts are often very burdensome.  Many types require the grantor to relinquish all control of the asset in order to gain the desired level of protection.  For some, that protection may be worthwhile, or even necessary.  But for those who want to continue using the asset, or believe they may need the asset in the future, then an irrevocable trust is likely not for you.

Domestic asset protection trusts offer protection while not conceding all control and ownership over the asset.  These trusts, however, are very expensive to create and require the specific circumstances to create as described above.

A revocable living trust offers many benefits to your heirs while offering you the peace of mind of knowing where your assets will go.  Revocable living trusts alone do not protect your assets from creditors and lawsuits, but they do offer a number of benefits, and at a much more reasonable price than an irrevocable trust or DAPT.  

Need Advice?

Determining which trust would be right for your unique situation can be a daunting task.  At Rosenblum Law, we recommend speaking with an experienced attorney so that your needs are properly assessed and the best estate plan is set up to achieve your specific goals.  For a free consultation, call us at 888-235-9021.

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