Asset protection planning has many connotations and is often misunderstood. Generally, it is the holding or rearranging of assets such that the owner, the owner’s family, the owner’s business, or a combination, will be insulated from claims of creditors and lawsuits. There are several degrees or levels of asset protection.
The first level is generally provided by local law, and merely involves taking advantage of any exemptions that are protected from creditor attack. This level includes homestead exemptions, insurance, annuities and retirement plans. It also encompasses marital planning which may involve the re-titling of assets into a structure of ownership of the non working spouse who is less likely to be at risk.
The next level involves liability protected entities for your business and/or investment assets. These entities are corporations, LLCs and Limited Partnerships.
The next level involves the use of Irrevocable Trusts. Assets held by irrevocable trusts are protected from the beneficiary’s creditors in most situations. The exception here is that generally, you cannot establish a trust for yourself as beneficiary and insulate those assets from your creditors. This is referred to as a “self-settled” trust.
For example, a revocable trust provides no asset protection for the grantor during his or her life. Upon the death of the grantor, however, or upon the death of the first spouse to die if it is a joint trust, the trust becomes irrevocable as to the deceased grantor’s property and can provide asset protection for the beneficiaries, with two important caveats. First, the assets must remain in the trust to provide ongoing asset protection. In other words, once the trustee distributes the assets to a beneficiary, those assets are no longer protected and can be attached by that beneficiary’s creditors. If the beneficiary is married, the distributed assets may also be subject to the spouse’s creditor(s), or they may be available to the former spouse upon divorce.
Trusts for the lifetime of the beneficiaries provide prolonged asset protection for the trust assets. Lifetime trusts also permit your financial advisor to continue to invest the trust assets as you instruct, which can help ensure that trust returns are sufficient to meet your planning objectives. The second caveat follows logically from the first: the more rights the beneficiary has with respect to compelling trust distributions, the less asset protection the trust provides. Generally, a creditor ‘steps into the shoes’ of the debtor and can exercise any rights of the debtor. Thus, if a beneficiary has the right to compel a distribution from a trust, so too can a creditor compel a distribution from that trust.
The next level involves combining the utilization of liability protected entities such as LLCs with the utilization of Domestic Asset Protection Trusts – often referred to as “DAPT”. Fifteen states have now adopted favorable legislation that provide asset protection for assets placed into an irrevocable trust, even if the irrevocable trust permits income or principal distributions to the grantor of the trust. These states are: Alaska, Delaware, Nevada, South Dakota, Missouri, Rhode Island, Utah, Tennessee, Wyoming, Oklahoma, New Hampshire, Virginia, Ohio, Hawaii, and Mississippi.
For an article describing this particular trust, follow this link: Charitable Lead Trusts