In the past, self-created trusts in the United States did not offer protection from creditors if the person who created the trust was allowed to receive funds from the trust. In order to get this asset protection feature, trusts had to be created in foreign countries such as the Cayman Islands, the Channel Islands, Belize and other lawsuit adverse jurisdictions. That has now changed. Thirteen states have enacted laws that prevent most creditors from attaching assets of irrevocable trusts even when the person who creates the trust is a beneficiary. The states are Alaska, Delaware, Missouri, Nevada, New Hampshire, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Wyoming, Hawaii and Colorado. It is now possible to create a trust in one of these states and receive the protection afforded by that state’s laws.
A person who is concerned about future claims to his or her assets may consider using a domestic asset protection trust. This requires that an irrevocable trust be established in one of the states listed above. The person who creates the trust cannot be the trustee. The trustee must be a resident of the state and the trust must be governed under the laws of that state. A spendthrift clause must be included in the trust. The trust terms must allow, but not require, the trustee to distribute income and principal to the person who created the trust. This means the person who creates the trust does not own the assets in that trust; therefore his or her creditors are prevented from reaching the assets.
Even though the trust is irrevocable, the terms can give the person who created it a special testamentary power of appointment over the assets. This allows the creator to determine who will inherit the funds on the creator’s death. The creator can change the ultimate beneficiaries at any time.
This type of trust can also be used in lieu of a prenuptial agreement. Instead of starting a marriage off by asking a future spouse to sign a contract contemplating a divorce, a person can simply create an asset protection trust before the marriage.
This type of trust cannot be used to avoid existing or soon-to-be existing creditors. A person who is aware of a claim or possible claim cannot create an asset protection trust and transfer assets simply to avoid attachment. The fraudulent transfer rules will still act to pull back assets. Also, since the law in this area is relatively new and few if any court cases have tested the legitimacy of these trusts, it is not absolutely certain how well the asset protection feature will work under the scrutiny of litigation.