Will a living trust help with asset protection?
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UPDATED: Jul 16, 2021
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Revocable living trusts are used by millions of people to transfer property to their beneficiaries upon their death and to keep their assets from going through probate. In general, however, they provide no asset protection benefits when it comes to creditors. Why? The main reason is that a trust is revocable, and with a revocable trust a settlor (the person who sets up the trust) can get control of the assets in the trust at any time. The courts have consistently held that where one can get control of the assets in his or her trust, his or her creditors can also get control of the assets.
Generally speaking, revocable living trusts are designed not for asset protection, but for estate planning purposes. This fact hasn’t kept some promoters from touting them as having special asset protection benefits, which is, for the most part, false.
There are ways to incorporate living trusts into an asset protection scheme, and some asset protection planners do use them, but these are typically used in conjunction with limited partnerships or offshore trusts. One other situation where living trusts may be used for asset protection from tax claims only, is the husband-wife living trust, also known as an A-B trust. Each spouse is allowed to take advantage of the $5.34 million lifetime exclusion. In this arrangement, each has a separate trust which allows both spouses to pass $5.34 million to the next generation (or other beneficiaries) tax-free. This scenario will not protect the assets from creditors outside the government for other than taxes.
There is a type of trust that can be more successfully used to protect assets, and that is the irrevocable trust. An irrevocable trust is an arrangement in which the grantor departs with ownership and control of the property in the trust. The trust then stands as a separate taxable entity and pays tax on its accumulated income. Because you no longer have ownership or control of the property in the trust, such a device has limited appeal to most people. But it is effective for asset protection. Once you set up an irrevocable trust, you cannot change the terms, revoke the trust, or have access to the assets in it. Since you cannot touch it, your creditors cannot either, so the property in it is safe. It is definitely a trade off.