Using A Domestic Trust For Asset
Protection
The laws relating to trusts are enormously confusing because there are
so many technical exceptions to every general rule. I'm going to try to
cut through some of the confusion as much as possible, while avoiding
any serious misstatements of law. Part of the confusion arises because
certain rules applicable to trusts are different for tax purposes and
for other purposes such as asset protection. Unless otherwise stated,
the comments in this report deal with asset protection.
Parties to a domestic trust
Every trust will have a grantor/settlor, one or more beneficiaries and
one or more trustees. Here are brief explanations of these terms.
1. Grantor/settlor
The person who establishes (whether directly or indirectly)
the trust is known as the grantor, settlor, trustor or creator. In this
report, I will refer to this person as the grantor.
2. Beneficiaries
Anyone who is to benefit from the income or the corpus
(assets or property) of the trust is a beneficiary. Generally, there
are
two types of beneficiaries. An income beneficiary is entitled to
receive
some or all of the income of a trust. The remainder beneficiary is to
receive whatever is left at the termination of the trust. A beneficiary
may be a contingent beneficiary and/or a discretionary
beneficiary.
3. Trustee(s)
In order to have a trust, there must be property that is
transferred to one or more trustees. The trustee is the person or
organization that is empowered to carry out the terms of the trust
agreement. Where asset protection is a major concern, the grantor of
the
trust should not also be a trustee.
Powers of Appointment
When anyone (usually a beneficiary or grantor) is given the power to
direct the disposition of trust property, the law calls that a "power
of
appointment". A power of appointment can be a general power or can be
limited.
A general power of appointment is one exercisable in favor
of anyone including the donee, his creditors, his estate, and creditors
of his estate. A power of appointment is limited when it is exercisable
only in favor of persons (or a class of persons) designated in the
instrument creating the power.
A power of appointment can be created within a trust or as
part of a power of attorney where the POA grants the attorney-infact a
general or limited power to appoint any trust property.
Revocable and irrevocable trusts
There are many different types of trusts because a trust is simply a
legal instrument that can be drafted to accomplish a wide range of
personal or financial goals. Some trusts are "living trusts" that are
created when the grantor is alive. "Testamentary trusts" are created by
a person's will.
A living trust can either be revocable by the grantor or it
can be irrevocable. The income tax, estate tax and gift tax rules vary
greatly between revocable and irrevocable trusts.
Asset protection
A revocable grantor trust provides absolutely no legal protection for
the assets in the trust from the grantor's creditors.
If a grantor puts property into an irrevocable trust for his
spouse and if the transfers are not found to be "fraudulent
conveyances"
(as explained later), then that property may be protected from the
future creditors of the grantor. This assumes that the transfer to the
spouse's trust does not cause the grantor to become insolvent at the
time of the transfer. If the spouse is also subject to the claims of
creditors, then a transfer into an irrevocable trust for the spouse
would protect the assets in the trust but not the income from the
trust.
When a grantor puts property into an irrevocable trust for
the benefit of his spouse, children, grandchildren or other heirs, the
only way that future creditors can reach the assets is to convince a
court that the transfer was made to intentionally "hinder, delay or defraud" current or potential creditors of the
grantor and that the grantor was insolvent
as
a result of the transfers to the trust.
Unless a trust has a "spendthrift clause", the beneficiaries
of an irrevocable trust can transfer the present value of their future
income from the trust, thereby making the money available to their
creditors.
