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How To Protect Assets From Creditors With A Trust

Living trusts can be helpful for estate planning, but a revocable living trust won’t adequately shield your assets from creditors. While it’s true that some trusts can protect assets from creditors and litigants, the typical revocable living trust – often used in estate planning – won’t help.

Revocable Living Trusts

Revocable trusts – particularly living trusts – are far more common than irrevocable ones. All trusts allow you to bequeath assets to your beneficiaries without interference from the court, protecting your estate from the prying eyes of the public. Trusts allow you to avoid probate, since property held by a living trust doesn’t need probate court approval prior to being passed on to your heirs. This allows your family to avoid the hassle and expense of a probate court proceeding – which would likely take six months to one year to complete – while it consumes three to five percent of the value of your estate.

Living trusts can have other benefits, as well. If you should ever become incapacitated, your successor trustee – the individual named by the trust to assume control after your death – can manage trust assets. This capability could prove to be extremely helpful in the event of an emergency or serious illness. While a revocable trust won’t protect you from creditors, you do have the comfort of knowing that you can change or revoke your living trust at any time.

Why Revocable Living Trusts Are Vulnerable To Your Creditors

While a revocable trust is useful for estate planning, it can’t protect your assets from your creditors. As trustee, you’re still in control of the trust assets, so you can’t simply disclaim them should legal claims arise against you. Your trust can, however, protect assets from your beneficiaries’ creditors. Spendthrift clauses permit your trustee to provide small regular payments to your beneficiaries, while preserving the bulk of your estate in the trust. Your trustee can withhold payments to your beneficiaries, and their creditors can’t force the trustee to distribute any assets held by the trust. The trustee can pay third parties directly on behalf of your beneficiary, preventing a creditor from attempting to seize funds from the beneficiary.

You can add property to the trust, remove it, sell it, or give it away anytime – without restriction. You can also revoke the trust altogether, in which case all assets will once again be held in your name. This also means that your creditors may be able to step into your shoes and revoke the trust.

Trusts To Shield Assets

While a simple trust to avoid probate won’t shield your assets from creditors, irrevocable living trusts are far more comprehensive. When assets are placed into an irrevocable trust – one that you don’t control and cannot revoke – these assets are no longer considered your own, and won’t be available to your creditors, even if you are a beneficiary of the trust.

An irrevocable trust is a particularly good option if you’ve already decided to begin gifting assets to your heirs during your lifetime, and if you don’t foresee needing any of those assets in the future. To be protected by an irrevocable trust, it must not be settled for your sole benefit. An irrevocable trust can only protect you against future creditors, so you should only transfer assets into the trust if you are confident that you have no present legal actions against you. If creditors are already pursuing you – or if someone just won a huge judgement against you – trying to protect your assets by forming and funding an irrevocable trust isn’t likely to work. Courts hold the power to revoke your trust if a judge believes that you transferred assets solely to evade creditors – especially if you have named yourself as a beneficiary.

To prevent a court from revoking your trust, you must not retain any power to revoke, rescind, or amend it, nor may you retain the right to reclaim the property you have transferred to the trust. You must not have any authority over the management of your trust or the property it holds. You cannot be the trustee – nor should your spouse, relative, or personal friend. If you don’t have an independent trustee, the courts can ignore your trust and your creditors can claim the assets it holds.

You can also protect yourself from lawsuits by titling your assets to a limited partnership – with you and your spouse serving as general partners. You can then transfer a portion of your partnership interests to your children every year through a trust. This allows you to reduce your taxable estate by shifting your limited partnership interest to your children’s trusts – and your assets will stay safe from your personal creditors, since they are titled to the limited partnership. There are hundreds of ways that you can effectively combine trusts, FLPs, LLCs, and corporations to attain various lawsuit protection objectives. And, you can achieve all of this while retaining lifetime control over your assets.

Operating a corporation properly is imperative since courts will often disallow the protections afforded by entities (e.g. pierce the corporate veil), if the corporation is little more than a personal piggy bank, or is otherwise deemed to be a shell.

The information herein is general in nature and should not be considered insurance, legal or tax advice.  Please consult with an insurance legal or tax professional for additional information on specific situations.    

Investment advisory services provided by Werba Rubin Wealth Management, LLC (“Werba Rubin”). Securities transactions are offered through a non-affiliated entity, Loring Ward Securities Inc., member FINRA/SIPC. WR 16-043

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