An asset protection trust (APT) is a trust that shields a grantor’s assets from future creditor claims. Asset protection trusts can be foreign or domestic, although not all states allow them.
Asset protection trusts are irrevocable in nature and come with added benefits, like minimizing estate tax. They must be constructed carefully in order to do what they purport to do (protect assets) so it is best to hire an estate attorney to set one up, which can become costly. A revocable trust, which can be amended, does not protect assets but is still suitable for many individuals and their estate planning needs.
How does an asset protection trust work?
An asset protection trust holds property that you don’t want to lose in a legal battle in the event that you are sued. The trust must be created well in advance of the lawsuit though; if you transfer assets into the trust just as you’re sued and called upon to pay a creditor judgement, then the court may consider you to have made a fraudulent transfer.
The grantor (or settlor or trustor) is the person who sets up the trust. They choose a trustee who must typically be a resident of the state where the trust is opened. The APT is constructed in a certain way to distinguish it from other trusts. It must be all of the following: an irrevocable self-settled trust, a spendthrift trust, and discretionary trust. That means the trustee manages the trust and makes distributions at their sole discretion to the beneficiary, which is the same person as the grantor. The grantor’s access to trust property is limited through a spendthrift clause.
→ Learn how to set up a trust in six steps
Additionally, the grantor can neither change nor revoke the asset protection trust because it is an irrevocable trust. The grantor is made to have little involvement and control over the trust on purpose so that from a legal perspective they don't own the trust property. When they are sued in court, a creditor cannot force a sale of the trust funds and assets.
Not all trust assets are protected equally from all creditor claims (exception creditors). Particularly in a divorce proceeding or child support case the grantor may have to give up trust funds (though this is more unlikely with an offshore trust, which we’ll talk about next).
Who needs an asset protection trust
Typically, only very wealthy individuals who are at risk of losing their assets through a lawsuit need an asset protection trust. Business owners may also consider this type of trust to separate their business assets from personal assets in the event that they are sued.
Types of asset protection trusts
Asset protection trusts mainly fall into two types: domestic and foreign trusts. There is also another type of trust, called a Medicaid trust, that offers asset protection.
→ Looking for a different trust? Read about types of trusts and which one is right for you
Domestic asset protection trust (DAPT)
A domestic asset protection trust is established in the U.S., but not all states legally recognize this type of trust. If you live in a state that doesn’t allow DAPTs, you can still open one in a state that does. The trust property would be subject to jurisdiction of the state in which the asset protection trust is created. However, this may get complicated during a lawsuit, as a state may get jurisdiction over your asset protection trust in another state. For more questions, consult with an attorney who can help with asset protection planning.
What states allow protection trusts?
Alaska
Delaware
Hawaii
Michigan
Mississippi
Missouri
Nevada
New Hampshire
Ohio
Oklahoma
Rhode Island
South Dakota
Tennessee
Utah
Virginia
West Virginia
Wyoming
Offshore asset protection trust
Another way to protect assets is to place them in a trust outside of the country. The assets would be subject to the laws of that country and not wherever the grantor lives. A foreign asset protection trust is usually established in countries like Bermuda or the Cayman Islands which have strict privacy measures that further shield the grantor’s assets. These trusts may also have the added benefit of serving as a tax shelter.
→ Learn more about how trusts are taxed
Medicaid asset protection trust
If you are trying to qualify for Medicaid, this trust can shield your assets from being counted towards the asset limit. It can also protect assets from being taken back in the future through Medicaid estate recovery if you received long term care. A living trust doesn't protect assets from a nursing home.
→ Learn more about Medicaid planning trusts
Cost of an asset protection trust
Asset protection trusts are complex financial planning tools and require the services of a legal professional, like an estate planning attorney. A simple trust may cost around $1,000, so you can expect to pay an attorney more to set up a trust with asset protection. An offshore trust could be even more expensive than a domestic asset protection trust.
In addition to legal fees, you need to pay maintenance costs, which can be expensive if you hire a trust company to serve as the trustee.
High net worth individuals may still find it worthwhile to set up this trust since it may help them save money in the long run. Fortunately for most people a revocable trust may be enough. You can get a revocable living trust and will with Policygenius.
