Asset protection trusts are a powerful tool within the realm of irrevocable trusts, designed to shield beneficiaries from the potentially adverse effects of transfer tax laws, divorce settlements, and future litigation. In these trusts, each beneficiary holds an equitable interest in trust assets, although they do not possess legal title to the assets themselves. It is very important that for any asset protection trust to work as planned, it cannot be set up with the intention to hinder, delay or defraud known creditors. All jurisdictions that allow for asset protection trusts have safeguards in the law to prevent abuse of these trusts by anyone seeking to intentionally defraud pre-existing creditors.

Key Advantages of Asset Protection Trusts

• Creditor Protection: Asset protection trusts serve as a legal means to safeguard assets against creditor claims while fully complying with laws and regulations. Creditors seeking access to a beneficiary’s trust assets are limited to the value of the beneficiary’s interest in the trust, rather than the entire asset value.
• Spendthrift Provision: Most asset protection trusts include a spendthrift provision, preventing beneficiaries and potential future creditors (including former spouses) from direct access to trust assets. Exceptions exist in cases where:
  • The trust creator is also a beneficiary (as in self-settled trusts, permitted in certain states).
  • A debtor is the sole beneficiary and trustee of the trust.
  • The trustee is required to meet a beneficiary’s child support obligations per a court order.

Important Considerations for Establishing Asset Protection Trusts

While Asset Protection Trusts offer compelling advantages, several crucial considerations merit attention:

• Varied State Regulations: Fewer than one-third of U.S. states permit the establishment of self-settled Asset Protection Trusts, and the laws and regulatory landscape differ widely from state to state. Skilled legal counsel is crucial to ensure that the trust is properly drafted in the best state to achieve the goals of the grantor.
• Choice of Trustee: The grantor must select a trustee residing in the state where the trust is created.
• Limited Control: Grantors relinquish control over distribution decisions made by the independent trustee. This is a necessary component to ensure that the trust achieves the tax and creditor protection goals of the trust. If the grantor retains too much control over trust assets, it could be contended that the grantor still has access to those assets and as such, cause those assets to be considered property of the grantor, which then runs the risk of being reached by creditors or returned to the grantor’s estate. Following the advice of skilled legal counsel in this regard is crucial.
• Anti-Abuse Safeguards: For an asset protection trust to function as intended, it is crucial that it is not established with the intent to hinder, delay, or defraud known creditors. Leading trust jurisdictions have instituted legal safeguards to prevent fraudulent transfers – attempts to conceal assets from pre-existing creditors. It is important to take the necessary steps when establishing a self-settled to trust to demonstrate honest intent and ensure there is no danger of fraudulent transfer.
• Legal Consequences: Courts often view trust transfers that lead to grantor insolvency unfavorably. Some states, such as Alaska, have minimum requirements in statute to prohibit insolvency when creating a self-settled asset protection trust.

Alaska, Nevada, and Delaware are among several top states to establish asset protection trusts, for both residents and for families residing outside these states.

Note: The information provided here is for general educational and informational purposes only. It is not legal advice and should not be interpreted as such. For a thorough understanding of these topics relevant to your specific circumstances, we recommend consulting a qualified estate planning attorney. Peak Trust Company cannot provide legal advice; however, we can serve as an informational resource and provide referrals to highly skilled attorneys who can offer legal and tax guidance tailored to your specific needs.