Asset Protection Series: Trust me, your assets are safe

In this first installment of my Asset Protection Series, we're going to discuss one of the most basic estate planning tools out there: the trust. 

A trust is an arrangement whereby someone with assets (the "settlor" or "grantor") wishes to entrust his/her assets with another person (the "trustee") to be managed for the benefit of another (a "beneficiary"). 

It is important to remember that for most legal purposes, trusts are not entities in and of themselves, and generally cannot sue or hold property in their own name. This varies depending on what state you are in, but as a general rule, the trustee is the legal person or entity that controls the assets, not the trust itself. It's why I refer to a trust as an "arrangement" because it is more like a contractual/fiduciary/agency relationship between the settlor and the trustee than it is a business entity.

Trusts can come in many flavors, but here are the most basic forms which you will come across most often:

1. The Revocable Living Trust

A "living" trust is one by which the settlor remains the beneficiary for the settlor's lifetime, and remains the trustee for this time period. Thus, one person (or a husband and wife) is the settlor, trustee, and beneficiary at the same time. As you could imagine, this is basically a legal fiction, and the IRS and other legal entities often ignore (or "disregard") revocable living trusts. A revocable living trust normally does not provide limited liability or asset protection from creditors.

The revocable living trust has one major purpose -- as a will substitute. The settlor/trustee/beneficiary, within the trust agreement, sets out who should be the successor trustee on his death, and who is the successor beneficiary upon death. In that document, the settlor can detail how the property should be handled after death. The settlor has a great deal of flexibility in this respect -- the trust documents can be extremely detailed as to how the assets should be handled, invested, distributed or used.

Once the settlor dies, the trust generally becomes irrevocable, and the successor trustee takes the reins. Assets generally avoid probate court, which in some states can be extremely time-consuming, complex, and expensive. No court appointments are necessary for the successor trustee to take power.

2. The Irrevocable Trust

The irrevocable trust is generally used as an estate planning tool in order to avoid taxes, cede control to others, or for Medicaid planning. In this arrangement, a settlor transfers assets to a trustee for the benefit of another, while retaining no control over the assets and sometimes limited controls over the trustee. Because the assets are now out of the settlor's hands, and the settlor can derive no benefit from the assets, the settlor can use this tactic not only for estate planning, but also to reduce taxes, protect the assets from creditors, provide for the income of a child, or become eligible to apply for Medicaid. These types of arrangement are often used in high-net-worth asset planning.

3. The Asset Protection Trust

An asset protection trust is a special kind of trust authorized by the laws of certain states (like Alasa, Delaware and Ohio) and offshore island governments (like the Cook Islands). These are special kinds of irrevocable trusts that often have characteristics of living trusts, where the settlor can also remain the beneficiary of the trust (though he/she cannot remain the trustee). Because the common law trust law in the United States often does not permit asset protection trusts, state laws must specifically authorize the creation of them. These states often place special restrictions on the structure of the trust, such as requiring a trustee to be a resident of the state of creation, and principal distributions to the settlor beneficiary are limited to a certain percentage of the principal of the trust assets. In return for following the state laws, these arrangements protect trust assets almost absolutely from creditors whose claims arise after the settlor funds the trust with assets.