One of the most common goals in estate planning is to ensure that your assets will pass on to your heirs upon your death, instead of your creditors. Trusts are particularly useful legal tools for protecting assets, but not every trust can accomplish that goal. Whether your trust is revocable or irrevocable, meaning whether its terms can be changed or not, makes a difference when it comes to asset protection. When clients ask whether revocable trusts provide asset protection, the answer, unfortunately, is no.
What is a trust and how does it work?
A trust is a legal agreement between the creator of the trust, or the grantor, transfers ownership of his or her assets into the care of another, known as the trustee. The assets will be managed for the benefit of the selected beneficiaries. The trust document sets out all of the responsibilities of the trustee with regard to the trust property. There are different types of trusts, but generally a trust is either revocable or irrevocable.
What is a Revocable Trust?
A revocable trust is one where the terms of the trust can be modified or canceled, depending on the wishes of the grantor. With a revocable trust, any income that is earned by the property in the trust is distributed to the grantor, as long as he or she is alive. Upon the grantor’s death, the property is transferred to the beneficiaries.
Why doesn’t a revocable trust protect assets from creditors?
Essentially, a revocable trust cannot protect your assets from creditors because the property is considered to still be owned by you. That is because, with a revocable trust, you retain the power to change the terms at any time and even terminate the trust if you wish. So, a creditor can force you to terminate the trust and surrender the assets, in order to satisfy a debt.
Trusts that WILL protect your assets
On the other hand, an irrevocable trust (one that cannot be modified or revoked once created) can provide protection for your asset, against your creditors. Once an irrevocable trust is created, you no longer own the assets that are funded into that trust. You no longer have control over how those assets will be distributed. Because you surrender your ability to modify the trust, you are no longer considered the owner of those assets, effectively protecting them from your creditors. This remains true, even if you are the beneficiary of the trust. The amount of protection each type of trust provides, depends in part on the laws of your state, however.
Beware of fraudulent transfers
If the court believes that you have transferred your assets to a trust simply to avoid paying creditors, the court has the power to undo those transfers as being fraudulent. So, it is very important to put your asset protection plan in place early, but certainly well before any significant debts are incurred.
If you have questions regarding revocable trusts, or any other asset protection issues, please contact the Schomer Law Group either online or by calling us at (310) 337-7696.