Asset Protection Trusts: A Basic Overview

Asset Protection TrustsWhat Is A Trust?

A Trust is essentially an agreement, or legal arrangement between the settlor or grantor, and the trustee. The settlor, also known as a grantor, agrees to transfer certain assets to the trustee and the trustee agrees to hold those assets for the benefit of named beneficiaries. In the past, trusts were used almost exclusively by wealthy families as a way to guard their assets from public scrutiny and also ensure that their assets were protected. Nowadays, people from many different income brackets are taking advantage of the benefits offered by a properly planned trust.

Why Are There So Many Different Types Of Trusts?

Trusts can seem confusing and intimidating, since there are many different types of trusts, each with slightly different sets of regulations and benefits, and with so many different types under many different names, it can appear as though there are more types than there actually are. The truth is that all trusts fit into just a few basic categories, each tailored toward a specific need and purpose. Some trusts have been around longer than others, and over time, have been given different names. For the purpose of this article, we will focus in closely on one of the more common types of trusts associated with estate planning, namely, Asset Protection trusts, Please note that this article is not intended to be a definitive guide to asset protection trusts, nor function as a substitute for advice from a qualified financial and legal professional.

Asset Protection Trusts

These types of trusts are designed to protect your assets from future creditors who might attempt to claim them after your death. There a several different types of asset protection trusts, including domestic asset protection trusts, foreign asset protection trusts, and self-settled asset protection trusts. (Sometimes referred to more generically as simply "asset protection trusts") These trust names are often used interchangeably and synonymously because of their similar legal restrictions, functions, and benefits. Who Should Establish An Asset Protection Trust?

Asset Protection Trusts should be established by clients who:

  • Have no current creditor problems substantially in excess of what is needed to cover any current and foreseeable claims.

  • Have concerns about claims that may arise in the future

  • Have assets that aren't needed to meet current and foreseeable living expenses, and want to have frequent access to the protected assets.

What Is The Tax Status of an Asset Protection Trust?

Generally, Asset Protection Trusts are treated as grantor trusts from the standpoint of income tax, unless distributions to the trustor have to be approved by an opposing party, such as a child, who would receive the assets not distributed to the trustor. Keep in mind, though, that regulations vary by state and that some states do not permit certain types of or variations therein, of Asset Protection Trusts, and that your personal situation is best determined b y a financial professional.

How Can Asset Protection Trusts Be Used?

Some, but by no means all, of the uses of asset protection trusts include:

  • To protect children who will be receiving significant assets once they reach the age of majority

  • To avoid state income or intangible taxes

  • To protect assets from future spouses and to avoid the type of financial disclosure that is often required in prenuptial agreements.

  • To protect personal injury awards

  • To protect CRTs and other estate planning vehicles such as GRATs, QPRTs, etc.

Domestic Asset Protection Trusts:

This type of asset protection trust (known also as a DAPT) must be established in the United States, and, like all types of asset protection trusts, is designed to shield your assets from creditors by transferring said assets to at third party, since virtually all US jurisdictions hold that the trusts created for third parties are generally not reachable by the beneficiaries' creditors. There is a bias against DAPTs, since many people believe that self-settled trusts are generally created with evil intent, but all U.S. jurisdictions have rules to set aside fraudulent trusts, which means that all of the states that currently permit domestic asset protection trusts have provisions in place to allow a creditor to reach any assets that were subject to an improper DAPT transfer.

Foreign Asset Protection Trusts:

Foreign Asset Protection Trusts (FAPTs) are very strong asset protection tools; although in some cases they may necessitate a move from the United States to the country where your assets are being held. This is because, in some cases, FAPTs are designed to hinder, delay, and defraud creditors, which is why you may see FAPTs being promoted under different names. When used correctly i.e. legally, FAPTs can successfully shield your foreign assets from US creditors, but because of their complex and controversial nature, you will want to ensure that an FAPT is a good option for you by discussing it with your certified financial planner and legal counsel.

Self-Settled Asset Protection Trusts:

If you create a trust for your own benefit, you have established what is known as a self-settled trust. If this trust contains provisions that prevent creditors from reaching your interest in trust assets, this trust is known as a "self-settled spendthrift trust," or more simply, an "asset protection trust." Remember that with Asset Protection Trusts, the names and designations are often used interchangeably, but as long as you know the basic concept, the names should not slow down your understanding. The real designation between a self-settled spendthrift trust and other types of asset protection trusts is simply what was stated in the paragraph above: that a self-settled spendthrift trust is put in place for the benefit of the grantor. Self-settled spendthrift trusts have been used for many hundreds of years, and the laws governing them, which can vary by state, have undergone numerous changes and additions, which is why it is important to become informed about the specific rules and governances of the state that you currently reside in.

Your Trust: Your Future Financial Security

Trusts are important tools for financial planning, and as this article has demonstrated, the wording and legalities of trusts can be confusing at times, which is why it is essential to consult a certified financial planner and legal counsel before making any type of decision regarding trusts, and particularly before attempting to draft one on your own. You've worked hard for your financial capital and assets, and as such, you should be confident that the investment choices you make today will secure your assets for the future.