Is a trust your best asset protection option? A trust may shelter you,
but most will not. America’s wealthiest families have historically
relied upon various trusts to protect their wealth from taxes. Now folks
from every economic background use trusts for myriad purposes. Asset protection
is one of the more important.
A trust is created by a settlor or grantor (the terms are interchangeable)
who funds or gives property to the trust. As the trust creator, the grantor
sets the terms under which the donated assets shall be managed and distributed.
The grantor names one or more trustees. The trustee may be the grantor.
The grantor designates the beneficiaries who are to benefit from the trust
and receive its income and principal. Certain trusts allow the grantor
to be both the trustee and the beneficiary. This is common with the living trust.
To consider a trust for protection, you must ask:
1) Which trusts can protect your assets from yourcreditors?
2) Which trusts can protect assets that you bequeath to your beneficiaries
from their creditors?
3) How can you improve your trust protection?
4) How much asset protection can you get from the different trusts?
You need an irrevocable intervivos trust to shelter your assets from your
creditors. Anytrust that includes the right protective provisions can
lawsuit-proof the trust assets from your beneficiaries’ creditors.
A trust is either intervivos or testamentary. A living trust is created
and funded during yourlifetime. It is an intervivos trust. Trusts that
you fund upon yourdeath are testamentary. You would usually create it
in your last will or living trust. During your lifetime, your assets remain
in your name and would be unprotected against your creditors, unless they
have otherwise been sheltered.
Trusts are also revocable or irrevocable. You can change or revoke a revocable
trust. You cannot revoke or modify an irrevocable trust. Every testamentary
trust is irrevocable once you die because you obviously cannot spring
back to life to unwind it.
It is important to distinguish a revocable from an irrevocable trust because
a revocable trust won’t protect you. For protection you need an
irrevocable trust. You also need an irrevocable trust that you presently
fund − an intervivos trust.
One serious disadvantage from using an irrevocable intervivos trust for
protection is that once you establish and fund the trust, you cannot cancel
or modify it and reclaim property you transferred to it. You thus lose
both ownership and control over the trust assets. That’s why an
irrevocable intervivos trust is seldom used for protection − though
such trusts can be useful for estate planning.
A revocable trust will not protect your assets because your creditors can
step into your shoes and revoke your trust. For example, assets titled
to your revocable living trust are vulnerable to your present and future
lawsuits. Nevertheless, a living trust will help you avoid probate. For
lawsuit-proof wealth, you need an irrevocable trust or another protective
entity. Since you cannot revoke or change an irrevocable trust, your creditors
have no greater power to unwind your trust and reclaim its assets. But
for an irrevocable trust to protect you, it must be presently
funded. Until you transfer assets to your trust, they are your assets, and can
be claimed by your creditors.
There are other limitations with trusts to shield assets. One limitation
is that you cannot settle your trust for your sole benefit. Forlawsuit
protection, you should have no beneficial interest in the trust. You can,
however, retain income rights based on some ascertainable standard (health
needs, etc.). Some states disallow self-settled trusts for asset protection.
The grantor can neither control the trust nor have anybeneficial rights.
Another limitation is that assets fraudulently transferred to the trust
can be recovered by present creditors. An irrevocable trust can protect
only against future creditors. You should only transfer assets to an irrevocable
trust when you are confident that you have no present creditors. But how
can you ever be absolutely certain of this? It’s more accurate to
say that you shouldn’t transfer assets to an irrevocable trust if
you have the likelihood of a present creditor. A present creditor can
recover assets from the trust because the transfer was without consideration.
In other words, you received nothing in exchange from the trust.
You can see the limitations with trusts. For protection, youmust use an
irrevocable trust, relinquish control, and beneficial interest, and still
your trust assets may be seized as a fraudulent transfer. Trusts are also
set aside when a court concludes that a trust is a sham or that the grantorretained
de facto control over the trust.
The irrevocable trust for asset protection imposes a heavy price that most
people want to avoid. They want less draconian ways to become lawsuit-proof.
An irrevocable trust can make sense when 1) you would soon gift the assets
to your beneficiaries anyway, and 2) you do not foresee needing the assets
for your future financial security. Your price, then, is not particularly
heavy, if you do not foreseeably need the assets, and the trust will now
accomplish what you would eventually do − distribute your assets
to your beneficiaries (usually your children) at some future time. Only
then, should you consider an irrevocable intervivos trust for wealth preservation.
Common Trust Pitfalls
Avoid three common pitfalls if you create an irrevocable intervivos trust.
First, reserve no power to revoke, rescind or amend the trust, or retain
any rights − directly or indirectly − to reclaim property
that you transfer to the trust. Attach nostrings to the assets that you
transfer to the trust.
Second, retain no authority on how your trust or its property is to be
managed or invested. And reserve no significant power over the trust.
You cannot be the trustee, nor should your spouse, relative, or personal
friend. Courts closely examine relationships between the grantor and trustee
to determine whether the trustee is only the grantor’s alter ego.
Unless your trustee is independent, the courts can ignore your trust and
yourcreditors can claim the trust assets. A corporate trustee, such as
a bank or trust company would not be considered your alter ego. Therefore,
their trusteeship will better protect your trust.
Because of these irrevocable trust disadvantages, most people choose other
methods to protect their assets. It also explains the popularity of limited
partnerships and LLCs which provide excellent asset protection, are revocable,
and lets you control your assets.
Revocable trusts (particularly the living trust) are far more common than
irrevocable trusts. A revocable trust can help you with your estate planning,
but not asset protection. Creditors can claim assets in a revocable trust
as easily as assets titled to you individually. If you can revoke or modify
your trust, your creditors can claim the assets for their own benefit.
Protect Your Children’s Inheritance
Parents may spend their lifetime scrimping, saving, and sheltering their
wealth, and leave their fortune to their children who spend or lose it.
A trust can safeguard assets you will leave to your beneficiaries. They
too have lawsuits, creditors, divorces, etc. How do you protect their
inheritance from their financial and legal problems?
You may not want an irrevocable trust to protect your assets, but it’s
frequently smart to set up a trust to protect assets that you bequeath
to your beneficiaries, particularly when the beneficiaries are yourchildren
Trusts can be intervivos or testamentary. With an intervivos trust you
transfer assets to your trust during your lifetime. A testamentary trust
receives your assets upon your death. Your assets are yours and stay vulnerable
to your creditors until you die, when title to these assets passes to
A revocable trust can protect the trust assets from your beneficiaries’
creditors. Whether you transfer your assets to the trust within your lifetime
or upon your death, the one difference between a revocable and an irrevocable
trust funded within your lifetime is that the revocable trust won’t
protect you as the grantor. Moreover, assets in your revocable trust will
be included in your taxable estate. Assets transferred to your irrevocable
trust during your lifetime will be excluded from your taxable estate −
provided you live at least three or more years thereafter.
Additionally, it is seldom prudent planning to gift substantial amounts
outright to children during your lifetime. You may make lifetime gifts
to your children to reduce your taxable estate, yet you have those same
ever-present dangers of your children squandering their gifts and you
losing control over these assets. A trust may also not be the best decision
in this scenario.
A smarter solution may be to title your assets in a limited partnership
with yourself (and your spouse) as its general partner. You can then transfer
to your children, through a trust, a portion of your limited partnership
interests each year. In this way, you reduce your taxable estate as you
shift your limited partnership interest to your children’s trusts.
Meanwhile, your assets will stay safe from your creditors because they
are titled to a limited partnership. You remain in control of your assets
because you would be the general partner. Your children’s inheritance
will be twice protected; once by the limited partnership and again by
their irrevocable trust. When you die, your remaining partnership interest
will have a discounted estate tax valuation. You can then bequeath this
remaining limited partnership interest to your children’s trust.
You have hundreds of ways to effectively combine trusts, FLPs, LLCs, and
corporations to achieve various lawsuit protection, tax, and estate planning
objectives. You can achieve all this while retaining lifetime control
over your assets. This should always be an important goal.
For a trust to fully safeguard your beneficiaries’ interest in the
trust assets, you need the right trust provisions. These clauses will
prevent your beneficiaries’ creditors from claiming their share
of the trust principal or income. The provisions will also stop the creditor
from asserting any rights that the beneficiaries may have to the income
or exercise other powers that could forfeit your beneficiaries’
The most important trust clause is the anti-alienationor spendthriftprovision.
This directly protects the trust assets from the beneficiaries’
creditors. The anti-alienation clause prohibits the trustee from transferring
the trust assets to anyone other than the beneficiaries. This includes
the trust beneficiaries’ creditors. The spendthrift or anti-alienation
clause expressly precludes anyone whose interest is adverse to the beneficiaries
(a creditor, ex-spouse, IRS, etc.) from claiming the beneficiaries’
share – whether it be the trust principal or income distributions.
This provision is vital for every trust.
The spendthrift clause won’t completely protect the beneficiaries.
There are limitations. Several states don’t enforce spendthrift
provisions. A spendthrift clause won’t always protect the beneficiaries
from bankruptcy, divorce, or tax claims. It won’t protect income
distributions previously received by the beneficiaries. Or a spendthrift
provision may be poorly drafted or narrowly interpreted by the courts.
Its protection largely depends on the drafter’s skill.
Another important protective clause is to give your trustee distribution
discretion. For example, your trust may provide that the beneficiaries
would receive trust distributions at age 25. But would those distributions
be safe if a beneficiary then has a judgment creditor? Or what if a divorce
A discretionary clause gives your trustee the right to withhold income
and principal distributions that would otherwise be payable to the beneficiaries;
if the trustee believes that the distribution would be wasted or claimed
by the beneficiaries’ creditors. This discretionary clause can also
prevent a wasteful beneficiary from depleting or wasting trust assets
— an important consideration when the grantors’ children are
the beneficiaries. If you have concerns about whether money that you entrust
for your children will be wasted, then add a discretionary provision in
your trust. Your trustee can then regulate distributions to your children,
avoid or minimize waste, and better prevent creditor seizure.
If your child is not a spendthrift, is his or her spouse? These same provisions
can keep the trust assets safe if your child dies or divorces. These provisions
can also apply to gifts to your grandchildren.
Spendthrift and discretionary clauses protect trust assets from your beneficiaries’
creditors. The trustee can withhold payments to your beneficiaries. A
beneficiaries’ creditor cannot force a trustee to distribute trust
assets to the beneficiaries. The creditor can only claim payments received
by the beneficiaries. However, the trustee can directly pay third parties
on behalf of a beneficiary. This circumvents a creditor attempting to
seize funds from the beneficiaries.
For still more protection, add sprinkling provisions to your trust. Sprinkling
provisions are common in trusts that are expected to remain in force for
ten or more years, and where each beneficiary’s future income or
tax situation is uncertain. The trustee can then modify trust distributions
through this sprinkling provision. The trustee can either disburse or
retain the principal and income for the duration of the trust. The trustee
thus determines what each beneficiary will receive, and when.
The trust grantor would specify criteria for the trustee to follow when
making distributions. Required minimum income distributions are recommended
when the beneficiary is a spouse or dependent child.
The sprinkling provision adds protection but you still cannot retain the
right to modify or revoke your sprinkling trust. As with any other asset
protection trust, your sprinkling trust must be irrevocable and you cannot
retain control. Moreover, your beneficiary cannot be a trustee. Although
legally permissible, the trust assets, in such instances, would become
vulnerable to the creditors of your trustee-beneficiary. A trustee, who
can distribute trust assets to himself as the beneficiary, gives his creditors
the same right to force distributions, which the creditor can then seize.
The living trust is very popular in America. A living trust helps you avoid
the cost and delay of probate. You can also avoid the dangers from jointly
owning assets. But a revocable living trust won’t protect you from lawsuits.
Though a revocable trust won’t protect you, you have the comfort
of knowing that you can change or revoke your living trust as often as
you can revise your will. But a living trust can cause you to lose lawsuit
protection? Several states have ruled that a homesteaded home transferred
to a living trust loses homestead protection. Similarly, assets owned
between spouses as tenants-by-the-entirety may lose creditor protection
from this type of co-ownership when those same assets are instead titled
to a living trust.
There are trade-offs between the different ways to title assets. Without
a revocable living trust, the court will distribute your assets under
your will. This can be expensive, time-consuming, and cumbersome. (Probate
costs can consume as much as 4% of an estate and delay estate distributions.)
If you bequeath $1 million through your will, your heirs may pay $40,000
in probate costs, and wait years for their inheritances. A living trust
circumvents the probate process. Your assets immediately transfer to your
Have the best of both worlds. Title your assets to a limited partnership
(to lawsuit-proof these assets). Have your living trust (which avoids
probate) own your limited partnership. When you die, your ownership in
the limited partnership immediately transfers through the living trust
to your heirs, and avoids probate. During your lifetime your assets would
be creditor-protected by the limited partnership.
Irrevocable Life Insurance Trusts
Life insurance is another important asset. Life insurance can have a substantial
cash value or death benefit exposed to creditors. Even a term policy without
cash value can be a valuable asset in that it will provide your family
income and support after you are gone. But will your beneficiaries get
the death benefit, or will your creditors? Life insurance can also pay
your estate taxes and make funds immediately available to your survivors;
thus avoiding the delay and expense of liquidating other assets.
If you own a large life insurance policy, title your insurance policy to
an irrevocable life insurance trust (ILIT). An ILIT is specifically designed
to own life insurance. As with other trusts, the ILIT has a trustee, beneficiaries,
and terms for distributions.
Your ILIT would own your insurance policy. The insurance policy beneficiary
would be the trust. When you die, your insurer pays the ILIT trustee,
who would follow the trust instructions and distribute the proceeds to
the ILIT beneficiaries. Your estate should not be the beneficiary.
An ILIT can be funded or unfunded. An unfunded ILIT’s life insurance
premiums are not fully paid. You fund future premiums (give annual premiums
to the trustee, who pays the premiums). With a funded ILIT, youtransfer
to the trust a fully paid insurance policy or enough income-producing
assets to pay the future premiums.
Whether you have an unfunded or funded ILIT, your policy premiums must
be directly paid from the trust. Youcannot directly pay the premiums or
you’ll lose both the trust’s tax benefits and creditor protection.
The ILIT is irrevocable. It protects the policy’s cash value, death
proceeds, and distributions from the trust to the beneficiaries. If life
insurance is not fully creditor-protected by your state laws, then an
ILIT is essential for protection.
The ILIT — though sometimes important for protection — can
save you estate taxes. Because the ILIT owns the life insurance policy,
the policy proceeds won’t be included in your taxable estate, nor
subject to estate taxes.
Assume you are single and die with a $3 million estate and $1 million of
that amount is life insurance. Assume that when you die you have a $2
million death tax exemption. Your estate would then pay an estate tax
on $1 million. If the estate tax is 50 %, your estate tax would be $500,000.
But your ILIT would remove the $1 million life insurance proceeds from
your taxable estate. Your estate would save $500,000 in estate taxes because
you reduced your taxable estate to zero.
The ILIT also gives you better control over policy distributions than insurance
owned by you personally. When you personally own insurance, your insurance
company directly pays the named beneficiaries when you die. An ILIT not
only lets you control who receives the proceeds, but also how and when
the policy proceeds will be distributed. For instance, you can specify
that the ILIT trustee pays estate taxes and other costs (taxes due on
IRAs or other retirement plans probate costs, legal fees, other debts, etc.)
before the trustee distributes funds to the trust beneficiaries. Or you can direct
your trustee to pay your beneficiaries over a period of months or years.
You can add spendthrift, anti-alienation, discretionary distribution,
and other protective provisions to protect the insurance proceeds from
your beneficiaries’ creditors. The ILIT can also avoid court interference
if a beneficiary becomes incompetent. Insurance companies won’t
pay life insurance proceeds to an incapacitated beneficiary. They require
court instructions. The ILIT avoids this unnecessary complication.
Do you intend to gift money to your children? Investigate an irrevocable
children’s trust (ICT). It can reduce taxes as well as provide protection.
Property that you transfer to a children’s trust cannot be seized
by your creditors. It also won’t be included in your taxable estate.
Income from the trust would be taxed at the children’s lower income
tax rates. These are the reasons for the children’s trust.
The ICT (or Section 2503 Minor’s Trust) by its terms, controls the
taxation and asset protection benefits of this trust. While the trust
is in effect and the beneficiary is under 21, neither the grantors nor
the child’s creditors can claim the trust assets.
There is one disadvantage with the children’s trust. When your child
reaches 21, your child can demand the trust assets. Since it is an irrevocable
trust, the grantor cannot withhold distributions from the trust. You cannotthusprevent
your child from receiving the assets that are then owned by the trust.
You can only extend the trust until a later age if your child, at age
21, consents in writing. Carefully consider whether your child (ren) at
that young age can properly handle the trust assets.
Charitable Remainder Trusts
Gifting your assets to charity may seem an extreme way to gain creditor-protection,
however, our tax laws allow you to give away your property to charity,
achieve protection, and use these same assets to generate income for you
during your lifetime. For protection, as well as the tax advantages from
gifting assets during your lifetime, the Charitable Remainder Trust (CRT)
can be your answer.
Here’s an overview of how the CRT works. As the grantor, you select
a tax-exempt charity as the beneficiary of your irrevocable trust. When
you create and fund the CRT, you make a charitable donation and can claim
an immediate tax deduction for the value of the assets contributed to
the trust. Although you have gifted the principal, you would be the income
beneficiary. Over your lifetime, your trust would pay you a fixed annual
income. You thus get an immediate tax deduction and future income from
the donated assets.
Assume that you have $200,000 in stocks that were purchased 15 years ago
for $60,000. If you sold the stock to invest in treasury bonds, you would
pay $21,000 in capital gains taxes on the profit (15% X $140,000 gain).
If your treasury bonds are worth $200,000 when you die, your estate may
then pay another $88,000 in estate taxes (although future estate taxes
are uncertain). Your heirs would inherit, after taxes, only $91,000 from
the original $200,000.
So, you don’t sell your stocks. Instead you transfer them to a CRT.
You get the same annual income as from treasury bonds for the remainder
of your life because you could be the CRT’s income beneficiary.
You deduct your $200,000 donation as an immediate charitable contribution.
The income from the tax savings from your charitable deduction can buy
a $91,000 life insurance policy to cover the $91,000 that your beneficiaries
would have received had you donated your stock to the CRT. The net result:
a large tax deduction this year, the same perpetual fixed retirement income
as with treasury bonds, you donate to your favorite charity, and the donated
trust assets are lawsuit-proof.
Do you have appreciated assets? Do you want a fixed lifetime income? Would
the CRT’s fixed income satisfy your retirement needs (adjusted for
inflation)? If so, a CRT may be a good protective strategy for you —
particularly if it can help you achieve your philanthropic goals. Income
from the CRTcan be seized by yourcreditors, but even then there are solutions.
For example, your income can be protected through a charitable remainder
annuity trust (CRAT), if your state exempts annuities from creditor seizure.
Other trusts are variations on this theme.
Qualified Personal Residence Trusts
With a Qualified Personal Residence Trust (QPRT, you transfer your residence
to the trust and retain a tenancy for ten years. At the end of the term,
your residence passes to your beneficiaries. Your objective is to transfer
your residence now at its lower value (basis), rather than when youdie
and it has a greater value. The QPRT thus reduces estate taxes.
A QPRT can also lawsuit-protect your home. Yourcreditors can only claim
yourright to use the property for the remaining term of years (or the
rental value for those years). However, your creditor cannot attach or
seize the home because it would be owned by the trust. The beneficial
remainder interest can be claimed by your beneficiaries’ creditors,
unless your trust includes those important spendthrift provisions. At
the end of the term, the trustee must distribute or convert the QPRT assets
into an annuity. This is a more desirable alternative in states that creditor-protect
If you are in a second (or third, fourth, or fifth marriage), the Q-TIP
(Qualified Terminable Interest Property) trust may interest you. The Q-TIP
ensures that your spouse will receive a lifetime income from the trust.
The trust principal then passes to your children (or alternative beneficiary)
after your spouse dies or remarries.
Q-TIPs are common with second marriages because they preserve your assets
for the benefit of thechildren from a prior marriage, rather than the
spouse’s children or family, who would become the probable beneficiaries
of an estate bequeathed outright to a surviving spouse. Q-TIPs can also
protect a spouse when the grantor believes that the spouse may waste the
assets during the spouse’s lifetime. A Q-TIP is essentially a spendthrift
trust to shelter your assets from your spouse’s creditors or subsequent mates.
Income from the Q-TIP trust must be used solely to benefit the surviving
spouse during the spouse’s lifetime, or the trust won’t qualify
for the unlimited marital deduction. Estate taxes on the principal are
deferred until the surviving spouse dies.
A Q-TIP trust won’t protect yourassets against your creditors, because
the Q-TIP is a testamentary trust. However, a Q-TIP trust can shelter
your wealth from a spendthrift spouse, a spouse who may have future financial
or legal difficulties, or a spouse who may wish to leave
your money to
his or her children.
The Q-TIP’s trust principal will be safe from your spouse’s
creditors, though the income to your spouse would not be protected. Moreover,
the trust income must be distributed as earned. The trustee cannot withhold
You can use a similar irrevocable intervivos marital deduction trust for
protection. The objective is to shift marital assets from the higher-risk
spouse to the less-at-risk spouse. This is only another form of lifetime
gifting. These transfers are also subject to fraudulent transfer claims.
A spouse who makes an outright gift must understand that the transferred
assets may be lost by a surviving spouse in a later lawsuit or in divorce.
It can also be lost to the spouse’s spendthrift spending.
Land trusts, widely used in Illinois, Florida, Georgia, California, Colorado,
and a few other states can partially insulate real estate against lawsuits.
The land trust can own any real estate — including the family residence.
A bank is normally the trustee. The land trust protects the beneficiaries’
interest in the real estate only if the trust has the proper spendthrift
and anti-alienation provisions. As the trust beneficiary, you don’t
directly own the real estate. The real estate is titled to the trustee.
You own only a beneficial interest in the trust. This interest is personal
property, not real property.
Owning a beneficial interest in a land trust is not sufficiently protective.
Your creditors can seize your beneficial interest. You need more protection.
One option is to title your beneficial interest to a limited partnership,
LLC or to an irrevocable trust.
Land trusts have two disadvantages. It is frequently difficult to finance
land trust property as it’s necessary to temporarily re-convey the
property out of the trust to its grantors or beneficiaries to complete
the financing. Also, a beneficiary desiring a Section 1031 tax-free, like-kind
exchange, must transfer the property from the trust, since a land trust
is not a beneficial interest in real property but an interest in personal property.
Privacy, not asset protection, is the land trust’s major advantage.
The beneficial owners won’t appear on the public records because
the property is titled to the trustee. To the extent secrecy aids protection,
the land trust can be helpful.
Nursing home costs can impoverish you as quickly as a lawsuit. Hence,
the Medicaid trust. This special purpose trust shelters assets so the
grantor can qualify for Medicaid to pay their nursing home costs. Medicaid
trusts, of course, chiefly interest those who prefer to leave their money
to their children rather than spend it on their own long-term care.
A Medicaid trust is similar to other irrevocable trusts. The grantor (as
an individual or couple) transfers their assets to an irrevocable trust.
However, unlike other irrevocable trusts, the grantor can be the income
beneficiary. Their children or spouse would be the residual beneficiaries.
The grantor can receive income from the trust to the maximum amount allowed
by Medicaid. But the now, asset-free grantor can qualify for Medicaid
nursing home assistance.
The Medicaid trust offers about the same asset protection as any other
irrevocable trust. Medicaid trusts prohibit using the trust assets for
other health care purposes, and it also limits the beneficiaries’
income to those income limits set by Medicaid. You must create and fund
your Medicaid trust 60 months before you apply for Medicaid. That’s
its one disadvantage: Few people can anticipate their long-term care needs
that far in advance.
Avoid Trust Shams
Also know which trusts to avoid. Promoters of pure trusts, common law
trusts or constitutional trusts ensnare a gullible public. These promoters
claim that these trusts predate our tax laws and are immune from taxation.
Or they claim their trusts can lawsuit-proof your assets. The tax claims
are nearly always bogus.
Pure trusts are shams. They won’t give you a legitimate tax benefit,
or other benefits beyond what you could get from other trusts. The IRS
has challenged these abusive trusts and penalized their promoters and
taxpayers who unlawfully used these trusts to avoid taxes. A grantor trust
requires the grantor to pay taxes on the trust income. An irrevocable
trust pays the taxes on its income. In either case, taxes are payable
on trust earnings. A trust is generally notthe way to avoid income taxes.
Can a pure trust creditor-proof your assets? Possibly. The answer depends
on whether the trust is irrevocable and whether you surrendered control
over the trust. The asset protection and tax benefits that one can derive
from any trust will be based solely on its terms and characteristics of
the trust, not the name of the trust.
Most pure trusts are simple, revocable grantor or nominee trusts. They
compare to living trusts. They will give you neither asset protection
nor tax benefits. Avoid organizations or promoters who claim their trust
enjoys special powers or immunities. Have your attorney prepare or review
your trusts. You want your trust to give you every benefit that you expect
— not huge tax troubles.
Gifting for Asset Protection
Gifting can be a sensible strategy to reduce estate taxes and protect your
assets. For example, you may save income taxes by transferring income-producing
assets to a recipient in a lower tax bracket. Gifts can also reduce your
taxable estate (and estate taxes) while you simultaneously reduce the
assets exposed to your creditors.
The annual gift tax exclusion currently lets you transfer $12,000 annually
per recipient, tax-free − provided your gift is immediately available
to the recipient. If you and your spouse jointly own and gift property,
your combined annual exclusion doubles to $24,000 per recipient. A couple
with three children can gift $72,000 annually, tax-free. You can accelerate
your gifting to more rapidly shift vulnerable assets out of your name.
¥ One option is to transfer your property in exchange for an installment
sale note payable over a number of years. You can forgive $12,000 installments
per recipient annually, without tax consequences. Your promissory note
would be self-liquidating and your transfer would be a fair consideration
exchange and therefore not fraudulent. To protect your note from your
creditors, title it to a limited partnership or LLC.
¥ A bypass-generation gift can accelerate your gifting. These gifts,
however, may impose a generation-skipping transfer tax of 50% (plus the
gift tax that applies to larger gifts). To avoid this tax, use a generation-skipping trust.
¥ Gift whatever assets are most vulnerable to creditors. Retain those
assets that are exempt from creditor claims or are otherwise protected.
¥ Another option is to transfer property to a minor child through a
children’s or minor’s trust. Or make gifts under the Uniform
Transfers to Minors Act. But you won’t get absolute protection if
your transfer is fraudulent. Your beneficiaries’ creditors, however,
cannot seize the funds until distributed to the beneficiaries.
Lawsuit-Proof Your Estate
You can have more debts than assets when you die. An indebted testator
may want to bequeath their estate to their heirs free of creditors’
claims. Most people fully pay their debts from their estates, but how
can you protect yourself if your debts exceed your assets when you die?
Or what if you are sued after you die? It happens. Arrange your affairs
so that your assets pass to your heirs free of lawsuits or creditor claims:
¥ Title your property jointly with right of survivorship to your intended
heir (or as tenancy-by-the-entirety). Jointly owned property passes to
the surviving joint owner free of creditor claims against the deceased
owner. (This is one exception to my prior advice not to own property jointly.)
¥ Title your property to an irrevocable trust funded during your lifetime (before you have creditors).
¥ Accelerate your lifetime gifts to deplete your estate (but avoid
¥ Invest in fixed annuities or other financial investments, which will
transform your wealth into an income stream which will pass debt-free
to your survivors.
While your living trust won’t insulate your estate from your creditors,
your living trust can give you limited protection. For instance, each
state sets a time limit for creditors to file claims against an estate.
With your assets titled to a living trust, you avoid probate. Avoid probate,
and your potential litigants may be less aware of your death. They are
then less likely to file a timely claim.
You may anticipate a big inheritance and have a judgment creditor. How
can you judgment-proof your inheritance? One solution is to disclaim your
inheritance. Any beneficiary can disclaim their inheritance. Thispasses
the inheritance on to the next generation. A disclaimer is a particularly
good strategy when you prefer your children to receive your inheritance
rather than risk losing it to your creditor.
A disclaimer is a complete and unqualified refusal to accept rights or
property. You can disclaim gifts and inheritances. Your alternate beneficiaries
may be your children, spouse, or anyone else you designate to receive
the gift. For a disclaimer to be effective, observe several requirements:
1) put your disclaimer writing, 2) you must not have previously accepted
any part of the property (or any benefits of ownership) and 3) your disclaimer
must be received by the transferor within nine months from the date of
the transfer or the date the document creating the interest (the bequeath
or gift) is made.
If you want to bequeath wealth and protect your beneficiaries, change your
will. Direct the inheritances to a protective entity that insulates the
inheritance from the beneficiaries’ creditors. For example, you
may direct the inheritance to 1) a domestic testamentary trust with spendthrift,
anti-alienation, and discretionary provisions, 2) an offshore asset protection
trust or 3) a limited partnership or LLC. The legacy directed to a protective
entity can be structured so that the full benefits of the gift or bequest
can still be enjoyed by the beneficiaries.
Six Tips to Build Trust Protection
There are many opportunities to increase trust protection.
¥ Never put your eggs in one basket. Use multiple trusts and different
trustees for different assets. Your creditor will have more difficulty
challenging several trusts. Multiple trusts also give you more flexibility
to accommodate multiple objectives, beneficiaries, or financial objectives.
¥ Use a foreign or offshore trust (not a domestic trust) to further
discourage litigation and maximize your protection.
¥ Incrementally transfer assets to your trusts. Smaller, staggered
transfers suggest those that were not intended to defraud creditors.
¥ Add innocent preambles to your trust. For example, your trust may
state an estate planning purpose.
¥ Include one or two beneficiaries other than yourself. A trust that
will only benefit you won’t protect you against either your present
or future creditors.
¥ Don’t control your trust. If you control the trust, your creditor
can claim its assets.