Explaining Domestic Asset Protection Trusts

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What Are Domestic Asset Protection Trusts?

As a means of protecting wealth, many people seek ways of minimizing tax implications while establishing plans to pass assets to beneficiaries after they die. One of the most common ways to do this is by creating a domestic asset protection trust.

In simple terms, an asset protection trust is an irrevocable trust or legal entity set up in a particular United States jurisdiction. They are designed to protect the valuable assets one has worked so hard to accumulate over the course of their lives. Once the trust is created, the person who establishes the trust transfers his or her assets to the trust. That person is often a beneficiary of the trust, retaining any economic benefits of those assets transferred into the trust while protecting the value of those assets from creditors.

Why Establish an Asset Protection Trust?

There are many reasons why someone might want to set up an asset protection trust. For those people with high net worth, a trust can be helpful in protecting assets from the claims of creditors. Others may wish to protect assets from any liabilities as a result of litigation. These people may include individuals in high litigation-risk jobs like medical professionals, attorneys, and corporate directors – people who may be at risk from lawsuits and the potential loss of assets stemming from those lawsuits.

Trusts can also be established to protect assets from the careless spending of an heir, such as a child or other beneficiary who may not have control over his or her spending. These are often referred to as “spendthrift trusts”, and they set up the trust with an independent trustee who has the authority to make smart spending decisions on behalf of the beneficiary. There is specific legal language that must be included in these trusts, including spendthrift clauses or provisions. Otherwise, the trust operates like any other.

A trust can also be set up to provide ongoing financial support for a disabled person, often a child or spouse of the trustor (the person who sets up and controls the trust). Finally, trusts may also be used in lieu of or in addition to a prenuptial agreement, shielding assets from claims by a future spouse in case of divorce.

State Regulations Regarding Asset Protection Trusts

Many states allow the creation of domestic asset protection trusts, but there are several that do not have statutes allowing them. The states that disallow such trusts do so out of concern of an individual shielding or protecting assets from legitimate claims by creditors. For individuals who have determined that they need the protection of an asset trust, there are workarounds to statutes. Several states, particularly Alaska and Delaware, will allow a non-resident to establish a trust in those states, regardless of residence.

Components of an Effective Asset Protection Trust

There are several aspects of trusts that determine whether or not those trusts protect assets in the way intended. These include:

  • A trust must be irrevocable; in other words, to protect the trustor’s assets from future claims by creditors, such a trust cannot be easily dissolved or revoked.
  • The trust must include the trustor as a beneficiary. This is sometimes referred to as a “self-settled trust”, and not all U.S. jurisdictions allow this.
  • A trustee, whether that is a person, a company, or some other entity, must be appointed and given authority to make decisions on behalf of the trust and its assets. In most cases, the trustee must be a resident of the state in which the trust was originally established.
  • The spendthrift clause must be included to protect assets from careless spending and to protect against claims of creditors.

Issues Surrounding Trusts

There have been many concerns over the years on the part of state officials and legislators about the validity of asset protection trusts. Because the concept is fairly new in the financial world, not many have been validated by courts. It is critical for people setting up a trust to understand that the validity of the trust may be challenged at any time by creditors and government officials.

Because not every state allows the creation of asset protection trusts, creditors may be interested in challenging those trusts that are established outside of a trustor’s state of residence. In the trust language when it is first established, specific language as to which state’s laws govern the trust needs to be included to protect against creditor claims.

Most importantly, an asset protection trust must avoid any appearance of evasion on the part of the trustor. In other words, some people have used these trusts to protect assets by fraudulently transferring those assets into the trust, putting assets out of reach of legitimate claims by creditors. Claims for child support are usually authorized against a trust; most states see child support as a legitimate claim and have crafted laws to disallow shielding of assets against those claims.

After-Death Benefits of Asset Protection Trusts

Estate planning is a valuable pursuit, and some people establish domestic asset protection trusts to ensure that their final wishes are carried out after death. Traditionally, people leave any assets to surviving heirs by way of a will. Probate, or the court hearing that determines the validity of the will and its distribution of assets, can be very expensive and time-consuming. Creditor claims and the court costs are paid for by the assets held by the deceased person, eating into the value of those assets.

An asset protection trust does away with the time and cost of probate hearings, thus protecting the value of the assets. As with any plan, seeking the help of a trust attorney and retirement planning specialists is a smart move. By using asset protection trusts to shield those assets against claims, a person’s heirs can receive financial benefits that the trustor intended them to have.

Sources:

http://www.thinkadvisor.com/2017/03/16/the-tax-advantages-of-domestic-asset-protection-tr?&slreturn=1490186186

https://en.wikipedia.org/wiki/Spendthrift_trust

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