creditor claims

Protecting Your Assets from Creditor Claims

Life happens.  Plan on it.™, is our tagline because, well, “life happens” and sometimes the “happening” is devastating.

Revocable trusts bypass the probate process and can ease the administrative burden left by a unexpected death.  But during the lifetime of the grantor (the person who set up the trust), a revocable living trust provides the grantor no protection from a financially devastating lawsuit or other creditor claims.  The lack of protection arises from the fact that the grantor is usually also the beneficiary (who benefits from the trust) and/or the trustee (the trust manager).  During the grantor’s lifetime, the grantor can revoke the trust and have all of the trust assets returned to herself in her personal capacity.  For all those reasons, revocable trusts do not protect the assets in the grantor’s revocable trust.  As we say, “if you can get to it, your creditor can get to it”

But if you place your property into an irrevocable trust, that is a different matter altogether.  Properly structured irrevocable trusts can protect your assets from many–though not all–creditor claims.

Irrevocable Asset Protection Trusts

Irrevocable asset protection trusts work to provide the grantor asset protection because in addition to giving up the right to revoke the trust and personally reclaim its assets, the grantor has made an additional tradeoff.   To provide asset protection during the grantor’s lifetime, one of the following must be true:

  1. The grantor is not the trustee but can be a beneficiary.  This type of irrevocable trust is called a self-settled asset protection trust and will be discussed in more detail below. Or

  1. The grantor is the trustee but cannot be a beneficiary (nor can the grantor’s spouse).  This type of irrevocable is one we call an iPug™ and is explained in our Estate Planning workshop.

Self-Settled Irrevocable Asset Protection Trusts

Virginia is one of a few states that permit what are known as “self-settled spendthrift trusts,” which is an irrevocable trust that shields your assets placed in the trust from future creditor claims. With a self-settled irrevocable trust, the grantor and the trustee must be different individuals. Once the trust is created and funded, the grantor no longer has the unilateral power to revoke or alter the terms of the trust.

The basic idea is that you transfer certain assets to a qualified independent trustee–i.e., someone who is not you, a family member, or a business entity under your control. In many cases, the trustee is a financial institution or professional fiduciary.  The trustee will then make regular distributions from the trust to you and at least one other beneficiary.

For example, if you create an irrevocable asset protection trust and fund it with stock for the benefit of you and your children, your creditors would not be able to touch the assets. The qualified independent trustee assumes full control of the trust’s assets and is the effective owner of the assets, subject to the terms of the trust document.

Asset protection trusts of any type will not protect you against creditors who already have a claim against you.  Because an asset protection trust offers no protection against existing claims, do not wait for someone to sue you before setting it up!  By law, a creditor with an existing claim can still go after the trust’s assets for five years after its creation. But creditors whose claim arise after the trust’s creation is out of luck–they cannot touch the assets so long as the assets remain under the trustee’s control.

There are, of course, a number of caveats here. For one, an asset protection trust will not protect you against federal or state tax claims and certain other types of debts such as child support. You also cannot use the trust to render yourself “insolvent”–i.e., you must still keep assets in your name to pay your anticipated bills. Finally, you cannot refuse the periodic distributions from the trust, which once received by you are then subject to possible creditor claims.

Need Advice on Protection from Creditor Claims? Contact Us Today

Irrevocable trusts are complex legal documents that require careful drafting and review. If you are interested in learning more about the process, please call Promise Law today at (757) 690-2470 or register to attend an upcoming informative, free workshop called “The 7 Hazards to Your Estate Plan” to learn more about estate planning. You can also contact us by clicking here and we will be happy to help you!


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