Is an Asset Protection (Spendthrift) Trust a Good Idea?

Many people think that the most common type of living trust, which is the revocable living trust, provides asset protection. Unfortunately, this is not true. The reason is that a revocable living trust is considered a 'self-settled' trust because you still control the assets you placed in the trust. Since you control the assets, they are subject to claims of your creditors. The assets in the trust are also subject to claims after your death by the creditors of your estate.

However, in a few situations, a self-settled revocable living trust might be able to provide asset protection. Those situations mainly involve trusts formed under Domestic Asset Protection Trust (DAPT) laws, which are enacted in only Delaware, Alaska and Nevada. Trusts which are created under these laws are commonly referred to as Delaware Trusts, Alaska Trusts or Nevada Trusts. These three states, in different ways, let you form a trust for your own benefit and protect the trust assets from any creditors. Sometimes these trusts are known as a 'self-settled spendthrift trust' where 'spendthrift' refers to the asset protection part of the trust. This means that you are shielding your assets from being 'spent' by any of your creditors.

The DAPT laws are rather new and have not been extensively tested, meaning that Domestic Asset Protection Trusts can be extremely risky. It is inevitable that questions will arise when a DAPT trustee is sued in another state (outside of Nevada, Alaska or Delaware) about creditors being able to attach assets in self-settled revocable living trusts. If this happens, the DAPT would have been a waste of time and money.

You might be wondering how the trustee would be sued in another state. If the trustee or settler lives outside Nevada, Alaska or Delaware, they can be sued in whichever state they happen to be in. Also, if trust assets are located physically in another state, that might give a basis for suit in the asset(s)' state.

When a suit is brought in a different state, it could be difficult to get a judge in that state to apply the DAPT law of a the state the trust was created in. There have not been many instances of this so nothing is certain. For example, if the trust is formed in Alaska, but the assets are in Kentucky; then the suit might be brought in Kentucky and Kentucky law would likely control. So...the assets might not be protected after all.

If the suit was brought about in Federal Court, this brings even more questions into the equation. Even if all the assets, the trustor and trustee were in a DAPT state, it might happen, if the creditor was in a different state. And, we can't always control the location of our creditors.

It should also be noted that amendments to the Bankruptcy Code in 2005 invalidated self-settled trusts if they were created within ten years of filing for bankruptcy, if they are meant to delay, defraud or hinder creditors. The aim of an Asset Protection Trust is, of course, actually to hinder and delay the creditors!

So, it seems like the overwhelming public policy in the US is to prevent people from shielding their assets from creditors by using trusts which they make and control for their own benefit. That does not mean that a Domestic Asset Protection Trust will not work. In certain situations, it might. Just be careful and maybe don't 100% count on it.

If you really want good asset protection, an irrevocable living trust might be what you are looking for. Or, you might consider an offshore trust. Finally, think about whether the assets you want to protect could be protected from certain creditors by being placed in a corporation.

For a Free no obligation consultation call Tom at (702) 907-0029