Living Trusts: How Safe Are Your Assets?

Creditors and Lawsuits

“Transfer your assets to a living trust and hide them from your creditors.” This is often applied too broadly. Solely placing your assets into a trust does not give you unlimited protection against creditors and lawsuits.

Let’s start with a quick overview of a revocable living trust. A trust is a legal arrangement where property is held for the benefit of someone. Basically, you entrust title to your assets to someone who is instructed to use and manage those assets per the terms of the trust document.

A trust is revocable if it contains language that allows you to change your mind and terminate or modify it. In some states, the Probate Code specifically states that all trusts are revocable, unless specifically stated otherwise.

A trust is called a living trust because it is set up by you while you are living. If you set up a trust through your will, it’s called a “testamentary” trust since it is created through your last will and testament.

The right to revoke your trust means you can remove any asset from the trust title at any time you choose. Since you have the right to revoke the trust, you are treated as the legal owner of the trust assets for purposes of income tax law or creditor collection law.

Generally, revocable living trusts do not protect your assets from creditors because you can remove any asset at any time. Your creditor can just force you to remove the asset for repayment. However, irrevocable trusts can provide greater protection against creditors and lawsuits.

They can also be used to protect certain irresponsible beneficiaries from themselves. A spendthrift irrevocable trust, in particular, is used for beneficiaries that have trouble managing their own money for whatever reason.

In the case of an irrevocable spendthrift trust, the money in the trust is sheltered from the beneficiary’s creditors since he does not, nor did he ever, own the assets held inside the trust. The creditors can only get his monthly draw once he gets it, but the main trust is sheltered for his benefit.

Finally, the best way to protest your assets from creditors is to create an irrevocable trust. However, once it is created, it is harder to remove assets and change beneficiaries.