Does a Revocable Living Trust Provide Asset Protection, Creditor Protection, or Divorce Protection?

Asset Protection and the Revocable Living Trust

The objective of asset protection planning is not to stiff legitimate creditors. On the contrary, good asset protection planning assumes you, the target of the litigation (referred to as the “debtor”), will pay all just debts and not attempt to use asset protection planning to unfair advantage.

Instead, the object of asset protection planning is lowering your asset profile. This is done to discourage frivolous lawsuits as well as thwart identity theft, phishing (being tricked into giving someone confidential information), pharming (being redirected to a criminal’s website rather than a legitimate one), and similar criminal schemes by keeping the assets out of your own name.

By transferring assets into a Revocable Living Trust, the assets are no longer held or reported in your name and thus it is much more difficult for criminals to find or access either the account information or the assets themselves. Thus, even if your identity is compromised and accounts accessed, the assets held in Trust should be unaffected and thus available for transfer to your new accounts to pay bills, etc., while the identify theft matter is being resolved.

In this way, a Revocable Living Trust can provide you with some degree of privacy and thus keep criminals from stealing your assets via identity theft or other similar schemes. However, a Revocable Living Trust cannot keep a creditor from getting to your assets. It does make it more difficult for creditors to access these assets; before doing so, the creditor must petition a court for a charging order to enable the creditor to get to the assets held in the Trust. But, if you get sued and lose, a court can order you to revoke the Trust and pay the creditor.

The Trust can be created to provide creditor protection to the beneficiaries of your Revocable Living Trust. Since a Revocable Trust becomes irrevocable upon the death of the grantor, an “anti-alienation clause” or “spendthrift clause” protects the assets held in the Trust from being used as collateral by the Trust beneficiaries. While the assets are held in the Trust, the beneficiaries do not have control over the property, and any distributions are subject to the Trustee’s discretion. Depending on the terms of the Trust, creditors cannot force a Trustee to make a distribution to the Trust beneficiaries; thus the assets held in a Trust can remain outside the reach of the beneficiaries’ creditors (until distributed into the hands of the beneficiary).

Providing More Asset Protection

No matter who you are, you have exposure to potential creditors. If you own real estate, either as a primary residence or as a rental property, you have opened yourself up to litigation. All it takes is for someone to slip on your sidewalk! But don’t think that by not owning property, you can avoid exposure. Certain occupations, like physicians or accountants, have a high degree of liability. Even simple, every day acts like driving a car or going shopping can lead to accidents that cause some sort of litigation. So, how do you minimize these risks?

Let’s look at a few of the most common ways estate planning tools maximize asset protection.

  1. The Children’s Trust: Transferring your property to your children is one way to keep your assets protected. The IRS will allow you to give up to $14,000 per person per year absolutely free of gift tax. If both spouses join in the gift, you can give up to $28,000 a year, gift tax-free. Since the assets will no longer be in your name, they are no longer in reach of plaintiffs or creditors. Keep in mind that you cannot transfer assets if you already have a claim or lawsuit pending against you. Additionally, a Children’s Trust is not revocable. Therefore, you must be sure that you can live without the benefits of the assets because you will not be able to change the title once it is put into Trust.
  2. The Irrevocable Life Insurance Trust (ILIT): With insurance policies, your premiums and interest earnings can really add up. This makes them a big target for creditors. By setting up an ILIT, you name a Trustee other than yourself and the policy is owned by the ILIT. This makes the policy out of reach of creditors.
  3. Family Limited Partnership (FLP): A FLP is a limited partnership. When you transfer your assets into an FLP, you typically receive only 2 percent of the partnership’s interests in general partnership interest, thus giving you all of the decision making control. The other 98 percent of the FLP is in the form of limited partnership interests. You can now give your children some of the limited partnership interests. This entitles them to a percentage of distributions made, but does not give them the power to insist upon distributions. Thus, if a plaintiff wins a suit against you, they can demand that distributions be paid to them but they cannot interfere with your powers as a partner.
  4. Foreign Asset Protection Trust: With a foreign Trust, you are the Trustor and the Trustee is a Trust company that operates outside of the United States in a jurisdiction that does not recognize United States Therefore, U.S. courts and judges have no jurisdiction over the foreign Trustee and the limited partnership interest. In a typical Trust, the Trustee is given discretion to accumulate or distribute Trust income among a specified class of beneficiaries. You may be one of the named beneficiaries, together with your spouse, children, or grandchildren.

Divorce Protection and the Revocable Living Trust

Many states have statutes which preclude an ex-spouse from inheriting under a Will created during marriage. Some of the statutes also apply to Trusts and beneficiary designations on life insurance or retirement plans. However, the laws vary tremendously and resolution of the matter can be further complicated where a divorce occurs in one state, but the estate plan or beneficiary designation is governed by the laws of another state or the federal government.

The assets in the Trust and the earnings on those assets may not be considered marital property or community property and may not be subject to division by a court in a divorce proceeding. Keep in mind that most states have an “elective share statute” which provides that your spouse (whether estranged or not) will automatically be entitled to a certain percentage of your estate. However, through proper planning, there may be a number of ways to avoid or limit the assets that are subject to the elective share, and to provide that your estranged spouse does not receive more of your estate than you want him or her to.

Once you have decided to divorce, you should have all your estate planning documents and beneficiary designations reviewed. In particular, you’ll have to review your fiduciary designations with the following questions in mind.

  • Who is designated as the Trustee of a Trust?
  • Who is the executor/personal representative of a Will?
  • Who is the agent under a Property Power of Attorney, Health Care Power of Attorney, or Health Care Proxy?

In the case of divorce, you may find that revoking your Living Trust is the best alternative. A brief written agreement is prepared, indicating that the Trust is now revoked. The assets are removed and put in the name of the individuals, who are free to establish new Trusts if they so desire.

Now that you understand the concepts of estate planning and asset protection, you will be in a much better position to obtain the desired effect (i.e. avoiding Probate, avoiding lawsuits, etc). Additionally, you are better able to understand how to use your Living Trust and other tools correctly. Nonetheless, this is a very complicated process. Always seek the help of a qualified estate planning attorney when determining what tools are needed for estate planning and asset protection.

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