Asset Protection- Irrevocable Trusts and Marital Agreements

Asset Protection- Irrevocable Trusts and Marital Agreements a Brief Overview

When I tell people that I am an estate planning attorney, they often ask about trust planning and wonder if they "need a trust." If a person is engaged in a high risk activity, where they risk having creditor's come after them I explore irrevocable trusts and marital agreements with them as a way to protect their assets.  

  Irrevocable trusts can provide asset protection by protecting the assets in the trust from the liabilities of trust beneficiaries and the trust creator (or settlor).  Assets placed in an irrevocable trust are protected from the liabilities of the beneficiaries if the beneficiaries do not have a certain and defined interest in the trust (the beneficiaries interest is contingent on a future event or subject to the discretion of the trustee); or the trust agreement includes a spendthrift provision which prevents creditors from making claims against the beneficiaries’ interest in the trust and prevents the beneficiaries from transferring or pledging their interests.  If the trust language includes these provisions, the only time assets would become subject to the beneficiaries' creditors is after the assets are distributed from the trust to the beneficiary.  As long as the trust assets are retained in the trust they are protected and can continue to provide for and benefit the beneficiaries beyond the reach of their creditors.

The irrevocable nature of a trust can also limit the reach of the trust settlor's creditors.  Since the trust is “irrevocable” the settlor cannot change his mind and either terminate the trust or take back the trust assets.  Upon transfer into the trust, the settlor has no power or authority to change the terms of the trust, use the trust assets or derive any benefit from the trust except as provided in the trust agreement.  As a result, in the absence of fraud, generally the creditors of a settlor cannot reach an asset within an irrevocable trust.   However, if the settlor retains any interest in the trust or the power to change the trust terms or dispositions, the settlor’s creditors may be able to reach the trust assets to the extent of the settlor’s retained power or interest.

 Off-Shore Trusts

Sounding quite glamorous and mysterious, off-shore trusts are trusts established outside the United States in a foreign jurisdiction.  These trusts attempt to provide the settlor asset protection, while still allowing the settlor control of the trust and the benefit of the trust assets.  Often the asset protection is derived from the fact that it is a difficult undertaking for a creditor to not only obtain a judgment against the settlor’s assets in a foreign jurisdiction but then also to collect against those assets.  In fact, some foreign jurisdictions implemented laws to make this process difficult for creditors to thereby encourage settlors to establish trusts in their jurisdictions (i.e., the Bahamas and the Cook Islands).  However, some of the same aspects that make these trusts unattractive to creditors also create risk for the settlor, as the assets are located in a foreign country and are subject to foreign laws and regulations.  The viability of off-shore trusts has been further eroded by increased reporting requirements for offshore trusts and holdings since 9/11 and recent court rulings such as the Anderson case, wherein the court held that the debtors could be jailed for failing to make assets held in an offshore trust available to the Anderson’s creditors. 

Self-Settled Spendthrift Trusts

A self-settled spendthrift trusts (“SSST”) is a form of irrevocable trust that offers greater creditor protection to the settlor while not requiring the settlor to give up absolute control and benefit from the trust assets.  Under a SSST, the settlor can be a beneficiary of the trust and can retain certain controls and authorities within the trust, such as the ability to direct investments or change the trust beneficiaries.  Once an asset is transferred to the trust, a creditor of the settlor has a limited period of time within which to challenge the transfer as an attempt to avoid a debt and assert a claim against the asset.  If the creditor does not make a claim within the proscribed time period, the asset is protected.  Even if the settlor later incurs a debt to the creditor, the creditor cannot reach the asset if the claim is not asserted within the proscribed time period.  The SSST is now authorized in Alaska, Delaware and Nevada.   

Marital Agreements:  Separation of Assets Between Spouses

A final technique asset protection technique that may be considered is the separation of assets and potential liabilities between spouses.  It may be possible to isolate the risks of one spouse (i.e., liabilities through a job or profession) to only that spouse’s separate assets, thereby gaining asset protection for the other spouse’s separate assets.  To achieve this separation, a written agreement between the spouses (a pre- or post-nuptial agreement) that clearly defines the separate property of each spouse is required.  Maintaining the separation of assets requires diligent management of assets and resources during the marriage to ensure that no marital property is created.  This technique would also only be effective to the extent that in the event of a creditor claim, the debtor spouse can show that the liability was incurred by the one spouse individually and not through a marital undertaking.  This type of asset protection planning also has additional ramifications.  In the event of divorce, the marital agreement would apply.  In addition, this technique could have estate tax consequences.  Careful planning is suggested when using this strategy.

Conclusion

When considering taking steps to protect your assets, it is important to keep in mind that no asset protection technique will shield assets from a creditor if the transfer is made in attempt to defraud or hide assets from a creditor with a potential claim.  In fact, such attempts may only compound the problem by turning a financial liability into a criminal liability.

It is also important to keep in mind that much like an estate plan, an asset protection plan must be carefully considered and tailored to meet each person’s individual circumstances.  With many life-legal planning techniques available and a myriad of ways to apply them, asset protection planning should only be done with the guidance of experienced professionals who can correctly analyze your situation and help you formulate a plan to best meet your needs.