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Updated on Monday, March 1, 2021
An asset protection trust (APT) is a type of trust that can be used to shield assets against creditors. Asset protection trusts can also be established as offshore accounts to hold bank accounts, real estate, personal property and other assets.
This type of trust is often more complex than a typical living trust and may not be right for every estate plan. Understanding how an asset protection trust works and what it’s designed to do can help you decide if creating one makes sense for you.
- What is an asset protection trust?
- Types of asset protection trusts
- Pros and cons of asset protection trusts
- How to set up an asset protection trust
What is an asset protection trust?
Generally, a trust is a legal entity that holds assets on behalf of one or more named beneficiaries and is managed by a trustee. Asset protection trusts, on the other hand, serve a specific purpose: to protect assets from certain third parties.
Those third parties most often include creditors who may pursue collection actions, including lawsuits, stemming from unpaid personal or business debts. But according to Ronald C. Morton, an estate planning and elder law attorney based in Clinton, Miss., asset protection trusts may also be useful for:
- People who desire to protect their children’s inheritance from the children’s own third-party creditors, or from a divorcing spouse
- People wishing to protect their life savings and home from being taken by the state, should they require nursing home care.
An asset protection trust is established by a grantor on behalf of one or more beneficiaries. A trustee is named to oversee the management of trust assets. The grantor can also be a beneficiary, though they cannot be the trustee.
Asset protection trusts are irrevocable, meaning the transfer of assets is permanent. In other words, once assets are transferred to the trust, they belong to the trust — not the grantor.
These trusts can include a spendthrift clause, which restricts the beneficiary’s ability to sell, spend or give away trust assets in violation of the trust terms. Asset protection trusts are also discretionary trusts, in that the assets can be distributed to beneficiaries based on the trustee’s discretion.
Types of asset protection trusts
There are two main types of asset protection trusts you can establish: domestic asset protection trusts and foreign asset protection trusts. When determining which one may be appropriate, it’s important to consider your estate planning needs as well as what your state’s laws permit with regard to asset protection trusts (APTs).
Domestic asset protection trust
A domestic asset protection trust, or DAPT, is established in the U.S. for the purpose of protecting assets. Currently, there are 19 states that allow domestic asset protection trusts:
- New Hampshire
- Rhode Island
- South Dakota
- West Virginia
Morton said that, while domestic asset protection trust states have their own laws, most statutes generally require the following:
- The trustee must reside in the state where the trust is established
- Trusts must place some limits on the creditor protections afforded
While DAPTs can offer flexibility with estate planning, state-imposed limitations can be a drawback. For example, assets may not be protected against liens, judgments or bankruptcy proceedings. Compared to a foreign asset protection trust, the protections offered against creditors are narrower.
Foreign asset protection trust
A foreign or offshore asset protection trust is established outside the U.S. Specifically, they’re established using offshore accounts. For example, you might create a foreign asset protection trust in the British Virgin Islands.
As such, foreign APTs are not subject to U.S. laws. Even if a creditor were to obtain a judgment against you, a foreign court in the same jurisdiction as an offshore asset protection trust wouldn’t be required to enforce it.
Foreign asset protection trusts can offer greater protections against creditor actions, compared to a domestic APT, along with enhanced privacy. An offshore asset protection trust could potentially offer a tax shelter as well. However, it’s important to note that foreign APTs may be subject to risks associated with political or economic shifts in the jurisdiction where your account is held.
Pros and cons of asset protection trusts
- Creditor protection: Asset protection trusts, when properly created, can shield assets from creditor lawsuits. The trust grantor can still enjoy access to assets held in the trusts without fear of creditors laying claim to them.
- Medicaid planning: Medicaid can be used to pay for long-term care expenses, but beneficiaries may first be required to spend down assets to qualify. An asset protection trust could remove assets from the grantor’s estate, making it easier for them to become Medicaid-eligible.
- Tax planning: APTs can yield several tax benefits, said Morton. Those include allowing beneficiaries to receive a stepped-up cost basis in property at the death of the grantor, retention of the homestead exemption for property taxes and tax-free treatment on gains associated with the sale of a personal residence held in an asset protection trust.
- Convenience: Asset protection trusts allow for the consolidation of assets. This can make estate planning and asset management easier.
- Complexity: Unlike a simple living trust, which you may be able to create using online software, asset protection trusts are more complex. You may need a skilled estate planning attorney to guide you through the process of creating a legally valid APT.
- Irrevocable transfer: Since APTs are irrevocable trusts, the transfer of assets is permanent. Once you transfer to them the trust, you can’t get them back, which could complicate your estate planning efforts later if your goals or needs change.
- State laws: As mentioned, not all states allow domestic asset protection trusts, so it’s possible you may not be able to establish one at all. And even if you do, your assets may not be entirely protected against creditor actions.
- Control: Transferring assets to an APT means giving up a certain amount of control. The spendthrift and discretionary clauses required for this type of trust limit your access to and control of trust assets as a beneficiary.
How to set up an asset protection trust
If you’re interested in establishing an asset protection trust, Morton advised consulting an asset protection trust attorney first. “Asset protection trusts are complex and dependent on multiple factors that must be considered, including the laws of the state of formation, state tax rules, federal tax rules and other considerations,” he said.
In terms of the actual process, it typically involves:
- Naming a trustee and one or more successor trustees
- Naming one or more beneficiaries
- Choosing which assets will be transferred to the trust
- Drafting a trust agreement
Once the trust agreement is in place, the trust must be funded. This simply means making the transfer of assets to the trust, which may be accomplished by retitling property in the name of the trust.
Be aware that this type of trust can be more expensive to set up. The typical asset protection trust cost will vary, based on how complex the trust is and whether you’re setting up a domestic or foreign trust. But you may expect to pay anywhere from $5,000 to $20,000 or more for the initial setup.
Again, keep in mind that not everyone needs an asset protection trust. Talking to a qualified asset protection trust attorney and/or your financial advisor can help you decide if one is right for your estate plan.