A Living Trust is generally not effective as an Asset Protection Trust.
One of the biggest living trust myths is that the most common type of living trust, the Revocable Living Trust provides asset protection. Sorry, it generally does not.
Because you still control the assets you placed in a Revocable Living Trust, it is considered a "Self-Settled" trust, and its assets are subject to claims by your creditors. After death, the assets in the trust are subject to claims by your estate's creditors.
So, generally speaking, there simply is no asset protection provided by a living trust.
I say "generally speaking" because there are some limited situations where a Self-Settled Revocable Living Trust could possibly provide asset protection.
Primarily, those situations involve trusts formed under Domestic Asset Protection Trust (DAPT) laws enacted in:
Trusts created under these laws are commonly called "Alaska Trusts," “Delaware Trusts or Nevada Trusts.
Essentially, those three states allow you (in different ways) to form a trust, for your own benefit, and shield the trust assets from your creditors. The trusts are sometimes referred to as a “self-settled spendthrift trust.” The term “spendthrift” refers to the asset protection aspect of the trust – essentially you are protecting your assets from being “spent” by being collected by your creditors.
In any event, the Domestic Asset Protection Trust laws were passed, in theory, to allow protections similar to the perceived asset protection afforded by offshore trusts.
The problem with Domestic Asset Protection Trusts is that they are very risky. The DAPT laws are relatively new and untested. There are many questions about what happens when the trustee of a DAPT is sued in one of the other (more than 40 states) that allow creditors to attach assets in self-settled revocable living trusts.
You may be asking yourself – how would the trustee get sued in a state other than the state the trust was formed in?
Once suit is brought in a different state, it may be an uphill battle to get a judge, in that state, to apply the DAPT law of a different state to the trust in question.
So, even if the trust is formed based on…say Alaska law; the suit against it might be decided based on…say Georgia law; and the creditor might be able to get at the assets.
There are even more questions about what law would apply if the suit was brought in Federal Court. This could happen even if all the assets as well as the trustor and trustee were all safely located in the DAPT state of the trust. The way it could happen is if the creditor was located in a different state.
And, how much control do you have over the location of your creditors? Not much!
It's also worth noting that the 2005 amendments to the Bankruptcy Code invalidate self-settled trusts, created within 10 years of filing for bankruptcy, if they are intended to hinder, delay or defraud creditors. Of course, arguably, the purpose of an Asset Protection Trust is specifically to “hinder” and “delay” creditors.
Frankly, it seems that the overwhelming public policy in the United States is to not allow people to shield their assets from creditors in trusts they create and control for their own benefit.
Actually, that makes sense. And there is a whole body of fraudulent conveyance laws in each state that will allow a court to invalidate a fraudulent trust and transfer assets in it to a creditor.
I would not say a DAPT will never work. Perhaps, it would, in certain situations.
But, I, for one, would not want to rely on protecting my assets with a Domestic Asset Protection Trust.
Truthfully, it seems dangerous to base your asset protection strategy on a DAPT (or a similar trust).
It is true that the privacy advantage of a living trust does provide some advantage when dealing with creditors.
Also, when assets are in a living trust, they are in the name of the trust. So, if a creditor wins a judgment against you, having to collect the judgment from assets in your living trust, will be a bit more difficult for him. He will have to get a court to issue a "charging order" to the trustee of the living trust.
So, a revocable living trust is a bit more difficult for a creditor to collect from (than if the assets were simply in your name. But, that difficulty certainly does not rise to the level of "asset protection."
The bottom line is that revocable living trusts are not asset protection trusts. That is a myth.
An Irrevocable Living Trust, by contrast, can be a very effective form of asset protection. However, you have to actually give the assets away; so the "medicine" may be worse than the "illness.”
If you are interested, you can read our article about Offshore Trusts. They do offer some advantages over a Domestic Asset Protection Trust. However, again, generally speaking, revocable living trusts are simply not effective for asset protection.
Asset protection really is not about finding a magic bullet that will prevent creditors from reaching any of your assets. If you think about it, that really would not be fair.
Asset protection, in the real world, is about intelligently isolating "dangerous assets" from other assets. For instance, it is perfectly legal and acceptable (even moral) to incorporate your sole proprietorship.
In so doing, you can (for the most part) limit your business liability to your business assets. Your home, for example, would be protected from liability for negligent acts by employees of your business.
That is the kind of legitimate asset protection strategy you should concentrate on. But, this is an area of the law beyond the scope of living trusts. In the future, we will be building a website to address these kinds of issues. Stay tuned.
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