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In an uncertain economic climate, your family’s financial security is subject to more risk. While you can’t mitigate every risk, one thing you can do is protect your assets from future creditors, such as those related to frivolous litigation, an unscrupulous business partner or a contentious divorce. One tool that can help is a trust.
Make sure it’s irrevocable
Trusts can be a great way to protect your assets — but the trust must become the owner of the assets and be irrevocable. That is, you as the grantor can’t modify or terminate the trust after it has been set up. This is the opposite of a “revocable trust,” which allows the grantor to modify the trust.
Once you transfer assets into an irrevocable trust, you’ve effectively removed all of your rights of ownership to the assets and the trust. The benefit is that, because the property is no longer yours, it’s unavailable to satisfy claims against you.
Placing assets in a trust won’t allow you to sidestep responsibility for any debts or claims that are already outstanding at the time you fund the trust. There also may be a substantial “look-back” period that could negate the protection that would otherwise be provided.
Consider a “spendthrift” trust
If you’re concerned about what will happen to your assets after they pass to the next generation, you may want to consider a “spendthrift” trust. Despite the name, a spendthrift trust does more than just protect your heirs from themselves. It can protect your family’s assets against creditors as well.
The trust also protects loved ones in the event of relationship changes. For example, if your son divorces, his spouse generally won’t be able to claim a share of the trust property in the divorce settlement.
Several trust types can be designated a spendthrift trust — you just need to add a spendthrift clause to the trust document. This type of clause restricts a beneficiary’s ability to assign or transfer his or her interests in the trust, and it restricts the rights of creditors to reach the trust assets. But a spendthrift trust won’t avoid claims from your own creditors unless you relinquish any interest in the trust assets.
Bear in mind that the protection offered by a spendthrift trust isn’t absolute. Depending on applicable law, it’s possible for government agencies to reach the trust assets to, for example, satisfy a tax obligation.
You can gain greater protection against creditors’ claims if you give your trustee more discretion over trust distributions. If the trust requires the trustee to make distributions for a beneficiary’s support, for example, a court may rule that a creditor can reach the trust assets to satisfy support-related debts. For increased protection, give the trustee full discretion over whether and when to make distributions. You’ll need to balance the potentially competing objectives of having the access you want and preventing others from having access against your wishes.
Create an offshore trust
Offshore trusts are similar to domestic trusts with the exception that they’re located in a foreign country — one with more favorable asset-protection laws.
When using an offshore trust, you may keep the trust assets in the United States. But relocating them to the country where you establish the trust generally offers greater protection. This is why offshore trusts are typically funded with cash or securities that can be readily moved, rather than with real estate or other property that could be seized by a U.S. court.
Research the options
These are just a few options to consider as you review whether creating a trust would be beneficial for you and your heirs. As you see, each type of trust has its own benefits and drawbacks. It’s important to examine these in detail with your financial advisor to ensure that the type of trust you establish will best protect your assets going forward.