Two Types of Trusts: Which Protects Against Creditors?

An important estate planning goal of yours may be to ensure that your money and other property ultimately pass to your heirs rather than to your creditors. One common estate planning tool used for this purpose is a trust. Essentially, a trust is a legal arrangement under which the creator (often called a grantor 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 you establish an irrevocable trust, you no longer legally own the assets you used to fund it and can no longer control how those assets are distributed. With careful planning by your estate planning attorney, you may still be able to indirectly benefit from the assets in the irrevocable trust. By creating an irrevocable trust, you surrender 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 your irrevocable trust. This is often true even when you establish yourself as the beneficiary of a discretionary trust. It is critical to understand, however, that the extent of protection turns largely on state law issues.

Importantly, a court can undo your 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 an experienced and credible estate planning attorney 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 during your lifetime. As a result, the trust creator maintains ownership of the assets. Therefore, a creditor could force the owner of a revocable living trust to terminate the trust and surrender the assets.