September 20, 2013   Estate Planning

Two Types of Trusts: Which Protect Against Creditors?


An important estate planning goal for many individuals is to be sure that their money ultimately passes to their heirs, rather than their creditors. One common estate planning tool used for this purpose is the trust. Essentially, a trust is a legal arrangement under which the creator (often called a “trust maker” or “settlor”) transfers ownership of assets into the care of another person (the “trustee”) to be administered for the benefit of another person or group of people (the “beneficiaries”). The document that establishes the responsibilities of the trustee and the rights of the beneficiaries is called the “trust instrument”, “trust agreement”, or simply “the trust.”
 
One type of trust that will protect your assets from your creditors is called an irrevocable trust. Once the trust creator establishes an irrevocable trust, he or she no longer legally owns the assets he or she used to fund it, and can no longer control how those assets are distributed. By creating an irrevocable trust, the trust maker surrenders the ability to later modify the trust instrument.
 
Due to this change in ownership, a future creditor cannot satisfy a judgment against the assets held in irrevocable trust. This is true even where the trust creator establishes himself as the beneficiary of a discretionary trust. It’s critically important to understand that the extent of protection turns largely on state law issues.
 
Importantly, a court can undo an individual’s transfer to a trust if it finds that the transfer was made with the intention of defrauding creditors. These transfers are considered fraudulent, and in many cases carry significant legal penalties. This is why it is important to practice asset protection planning well before you even anticipate being the subject of any liability. Moreover, it is imperative that you work closely with experienced and credible legal counsel before engaging in any measure of asset protection.
 
A revocable living trust, on the other hand, does not protect your assets from your creditors. This is because a revocable living trust can, by its terms, be changed or terminated at any time. Due to these terms, the trust creator maintains ownership of his assets. Therefore, a creditor could force the owner of a revocable living trust to terminate the trust and surrender the assets.

 

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