What is an Asset Protection Trust?
Protecting your hard-earned assets in a world that grows increasingly litigious is a daunting challenge – to say the least. As its name suggests, an asset protection trust, by definition, secures your assets for yourself and/or your intended beneficiaries and prevents them from being lost to creditors, divorce or predatory claims. Asset protection trusts come in varied forms, but they have the same goal. They are set up to safeguard your assets and reserve them solely for you and your intended beneficiaries.
How an Asset Protection Trust Works
To appreciate how an asset protection trust works and how it can live up to its name, that is, to protect your assets, it’s necessary to understand the difference between a revocable and irrevocable trust. As its name suggests, a revocable trust can be altered even after it has been set up. Additionally, in a revocable trust, the settlor typically retains substantial control over the trust assets. This can include when to distribute a beneficiary’s interest, where to invest, and whether or not assets can be sold.
The terms of an irrevocable trust may not be readily amended or altered at the sole discretion of the settlor. The settlor turns over the trust assets to the trustee. The trust company, or its successor, holds them for the beneficiaries for the life of the trust. The duties of a trustee are clearly defined in the trust deed. They can be quite varied in terms of scope and duration. Generally, but not always, these include the power to make investment decisions, whether to distribute an interest or not, and decisions of the sort.
Let’s say you have a revocable trust and a creditor wins a judgement against you. As the trust settlor, the judgement creditor can petition the court to have the trust pay out benefits the creditor instead of you. This is because you can change the terms of the trust. The legal concept here is that whatever you the debtor could do to the trust, the creditor could step into his shoes and do the same. It is not possible to do this with an irrevocable trust. This is because the terms of an irrevocable trust cannot be changed directly by the settlor after it has been properly set up.
The legal concept here is that whatever you the debtor could do to the trust, the creditor could step into his shoes and do the same.
An asset protection trust is an irrevocable trust, which is how it can live up to its name. Even if a creditor wins a judgement against you in court, the creditor cannot petition the court and force the trust to issue a benefit to himself. This is precisely because the terms of the trust cannot be changed by the debtor. Ironically, it is when you surrender some control over your assets that you are able to provide the best protection for them.
Third-Party Asset Protection Trusts
An asset protection trust can be a third-party trust or a self-settled trust. As indicated by its name, a third-party trust is set up by one party. That party is the settlor or grantor of the trust. It is, in turn, set up for the benefit of another party, the beneficiary or beneficiaries. Parents typically set up third-party trusts for their children while they are minors since minors cannot legally accept an inheritance. This type of trust is commonly called a children’s trust. The assets are held in trust for them until they reach adulthood, or another milestone that you, as the settlor, can specify in the trust deed. Third-party trusts can also be set up for adult beneficiaries. These may include a surviving spouse, adult children or a dependent with a disability.
What if a child develops a gambling or drug problem? As an adult and you don’t wish to have trust benefits go to feeding his or her addiction. If you word the terms of the trust deed carefully, you can address just about any eventuality. Adversely, let’s suppose you have a disabled dependent. If they are a trust beneficiary that it may prevent him or her from qualifying for government assistance later on. Thus, you can create a special needs asset protection trust. This way the trust benefits of your disabled dependent will not disqualify them from government assistance. It can instead be used to supplement their government benefits.
Puts You in Control
As the settlor of the trust, you can give the trustee broad discretionary powers regarding the distribution of benefits. You can stipulate exactly when and how the benefits are to be distributed. For example, a child may be entitled to substantial interest after he or she graduates from university or reaches a certain age. You can specify that trust benefits are to be used solely for medical purposes or for buying a house or starting a new business. Setting up a third-party asset protection trust for your loved ones will ensure that they are the ones who will derive the benefits of the assets in the trust rather than a predatory claimant.
Self-Settled Asset Protection Trust
You can also set up a domestic self-settled asset protection trust. These trusts allow you to transfer assets into the trust while retaining a beneficial interest. As long as the terms of the trust deed are drafted carefully, creditors will find it hard to penetrate it. This type of trust builds a wall around your assets. Keep in mind however, that domestic asset protection trusts (DAPT) are still relatively new in the United States. Up until 1997, when Alaska became the first state to legislate DAPTs, self-settled asset protection trusts weren’t even recognized in the U.S. To date, there are only 15 asset protection trust states.
It is essential that you set up your DAPT before any legal action is lodged against you. The statute of limitations period determines the amount of time that must transpire before a transferred asset are deemed safe from creditors. It varies greatly among states with DAPT legislation. It can run from 6 months to 6 years. States also differ on legislation regarding exception creditors. Examples include children who are entitled to child support or ex-spouses who are owed alimony. Exception creditors are those who may have access to trust assets that are otherwise off-limits to regular creditors. It is only the State of Nevada, which enacted its DAPT laws as early as 1999, that does not recognize exception creditors.
The general requirements for states with DAPT legislation are as follows:
- The trust must be irrevocable.
- at least one trustee must be a resident of the state.
- If the trustee is a corporation, it must be one that is authorized to conduct business in the state, and
- Some of the trust assets must be within state borders.
It is not necessary for you to be a resident of the state where you set up your DAPT. However, the more ‘ties’ you have with the home state of your DAPT, the better it will look in court should a creditor succeed in mounting a lawsuit against you. It won’t seem like you chose the state solely for its favorable DAPT legislation, even if, in fact, you may have.
The big challenge, however, with domestic trusts is that they are, well, domestic. So are domestic judges. Domestic judges have jurisdiction over domestic trusts. A results-oriented judge in California or New York or Florida or Texas may not care if the laws in Nevada statutes say the trust should theoretically protect the assets. If a judge is determined enough, the assets will be turned over to the creditor. In practice, we have seen this happen over and over again. It is all about case law; how the trusts have actually held up in court. The answer is not very well. So if domestic trusts are not the answer, what is? See the next section for the answer.
Foreign Asset Protection Trust
Offshore or foreign asset protection trusts (FAPT) offer all the layers of protection mentioned above, plus one major additional powerful feature. That protective benefit is the trust-friendly legislation of a sovereign country. Being independent nations with their own laws, these international jurisdictions will not automatically enforce a judgement or charging order issued by a U.S. or other foreign court.
If your creditor wants to access the assets of your offshore asset protection trust, he or she will typically be required to mount another trial within the foreign country. This is the case even if your creditor has already won a judgement against you in a U.S. court. A new trial in an offshore location can be a prohibitively expensive and extremely tedious undertaking for your opponent. None but the most determined (and perhaps foolhardy) creditor will attempt to launch a new trial in a foreign jurisdiction that openly promotes itself as a trust haven, as most of these countries do.
Statute of Limitations
In addition, the statute of limitations period is much shorter in these offshore jurisdictions. If you establish an asset protection trust in Belize for example, there is no time when your assets are vulnerable. This is because the country does not recognize a fraudulent transfer ruling against any Belize trust that has been properly established under its jurisdiction. The Nevis trust and the Cook Islands Trust have sliding windows of opportunity, from one to two years. But their laws begin the countdown from the time the plaintiff’s cause of action happened and not from the date the lawsuit was brought to a U.S. court for trial.
If you consider how slowly the American wheels of justice can sometimes run you can see the benefit. It is highly possible that by the time a creditor wins a judgement against you in a U.S. court, the window of opportunity to go after your trust assets in the offshore location is closed.
Asset Protection Trust Conclusion
The goal of an asset protection trust is just that – to protect your assets from being used for a purpose other than what you had in mind for them. It is best that you set up your asset protection trust before any legal action is taken against you. This is true whether you choose to establish a third-party trust or a domestic or international self-settled asset protection trust. The important message to bring home is this. Whether or not lawsuit has already been filed against you, you will almost always find that an foreign asset protection trust (FAPT) provides you with a more encompassing and effective protection than a domestic asset protection trust (DAPT).