You’ve Probably Heard That Family Living Trusts Can Avoid Probate, But Does Your Living Trust Also Provide Asset Protection For Your Family?

By Steven J. Gibbs, Esq.

You've Probably Heard That Family Living Trusts Can Avoid Probate, But Does Your Living Trust Also Provide Asset Protection For Your Family?Defining “asset protection” is a great first step to understand how to use your living trust effectively as part of a family asset protection plan.

Doing asset protection is about adopting strategies to legally protect your assets.  Assets are defined as anything that you own that has value.

A living trust does NOT provide asset protection for the person who created the trust (the “trustmaker”) but does provide asset protection for succeeding generations.

Thus, if the trustmaker of a living trust is sued, all of the assets held in the name of the Trust will be subject to liens and judgments.  Further,  all assets held in the name of the trust at the time of death will be subject to both state and federal estate taxes.

Why are living trusts not asset protected?

When we refer to a living trust, we’re also talking about a revocable trust, revocable living trust, intervivos trust, or any combination thereof.  We are not talking about an irrevocable trust and this is an important distinction because the “revocability” of the trust makes it unsuitable for providing asset protection for the trustmaker.

Why does revocability create a problem for asset protection?  

Revocability by definition means that a trust may be changed or terminated by the trustmaker at any time.  This results in a very flexible tool for the trustmaker that is great for certain legal strategies that we will discuss below.  Asset protection by definition requires that one’s assets be transferred to a separate entity of some type in order to be protected.  This is required because, if a judgment creditor seeks to attach a lien to your assets, you want to be able to say that they are in a separate entity that was intended to be inaccessible to future creditors.  Living trusts, which are revocable, are designed to be fully accessible by the trustmaker and thus would also be fully accessible by creditors.  On the other hand, living trusts are an integral part of a legal strategy that is not concerned about asset protection for the trustmaker.

What legal strategy you may ask?  

Living trusts were invented by the British in as alternative to, and to avoid, the ecclesiastical probate court system. So, they were invented to avoid the high cost and control issues inherent in the probate court process.  These issues still plague the court system today, and thus most people seek to have a living trust for this very same purpose.  As a bonus, living trusts are also good for managing estate assets with flexibility and protecting the trustmaker in the event of disability.

As trust law continues to evolve, new uses for living trusts arise, such as allowing flexibility for Medicaid planning, or dynasty planning.  Living trusts are also good for protecting children and grandchildren where estate planning for second marriages are concerned.

So this means…

A living trust is first and foremost used to provide a place to title your assets so that in the event of your demise, probate will be unnecessary.  A solid legal strategy utilizing a living trust means that it will be properly drafted to address the above issues based upon the unique circumstances of the trustmaker.  Your assets will need to be titled in the name of the trust, a process called trust funding, in order for probate avoidance and these other strategies to work.

Where does asset protection come into the picture with living trusts?

Living trusts come with a “twist” and that is the fact that when the trustmaker passes away, the living trust becomes irrevocable.   If the “now irrevocable” trust contains what is called a “spendthrift clause”, it has become an asset protection trust.  An important thing to clarify is that if a joint living trust was originally established and one of the joint trustmakers passes away, the trust remains irrevocable and is thus not asset protected.  It is only when the last trustmaker passes that the living trust becomes irrevocable.   Some additional steps may be required to establish the irrevocable trust such as obtaining a tax id number for the trust.  When the separate identity of the trust is established, it will come irrevocable.

Your trust beneficiaries thus can now take advantage of the asset protection offered by this spendthrift trust and this is the foundation of dynasty trust planning.

In any level of trust planning, it is important to identify what is most important to you.  It is also important make sure that your living trust includes the necessary provisions for asset protection, dynasty planning, Medicaid, disability, estate tax planning, and of course, probate avoidance.

As always, I hope this helps you in your estate planning journey.
Steven J. Gibbs, Esq.

GIBBS Law Office
239.415.7495 .

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