Asset protection can be big concern for some, especially those who own a business or commercial property. The potential for legal claims and constant existence of creditors make it even more important to have an asset protection plan so that you don’t run the risk of losing everything through some unexpected turn of events. There are different ways to legally protect your assets, including an irrevocable trust. Not every type of trust can accomplish proper asset protection. Here is why irrevocable trusts work.
The main goal of asset protection
Creating an asset protection plan involves a careful analysis of your assets and appropriate organization of those asset in a way that provides protection against risk or loss. A common misconception is that asset protection requires some type of fraud or “hiding” of assets. However, when done properly and within the bounds of the law, asset protection is entirely legal. You can be prepared for any unexpected situation that would otherwise put your assets at risk, and you can do so without engaging in any type of tax evasion or fraud.
What does it mean to be irrevocable?
Protection from creditors can be accomplished with different trusts, but the most efficient type of trust is an irrevocable one. The term “irrevocable” means that the document cannot be modified or rescinded once it has been created. Once it’s done, it’s done.
Why an irrevocable trust is better at protecting assets
First, when you transfer your property to any type of trust, that property then belongs to the trust. Second, because the trust cannot be revoked the assets are no longer considered yours in any way. For that reason, that property is no longer subject your creditors or legal liabilities.
Necessary terms for asset protection
In order to ensure that your assets will actually be protected, certain terms are required to be included in your trust agreement. For example, any interests that you leave to your beneficiaries must be contingent on a future event or subject to the trustee’s sole discretion. Another helpful provision is referred to as a “spendthrift” provision. Spendthrifts also guard assets from creditors, who are not able to make claims against the beneficiary’s interest.
Property must remain in the trust in order to be protected
Simply transferring an asset to a trust does not accomplish asset protection, unless the assets remains in the trust. In other words, if you ever remove the property from the trust, it no longer falls under the trust’s protection. Once removed, the property will become subject to creditor’s claims once again.
The difference between revocable and irrevocable living trusts
A revocable trust is the opposite of an irrevocable trust, in that it can be changed or revoked at any time, during your lifetime. Revocable living trusts become effective during your lifetime and allow you to manage the trust and the trust property completely. Then, upon your death, the trust property is transferred on to your named beneficiaries. Living trusts are typically used in conjunction with a will in estate planning. While irrevocable trusts are great for asset protection, revocable living trusts are great for avoiding the time and expense of the probate process.
Why revocable trusts do not provide asset protection
A revocable living trust cannot provide protection for your assets because the property in the trust is still considered to belong to you. You are named as the trustee so you will still have control over the trust assets during your lifetime. Since the property is essentially yours, it remains subject to the claims of your creditors. Furthermore, all of the income generated by your trust assets belongs to you, which you are required to report on your personal income tax return. These characteristics make a revocable trust unfit for protecting assets.
Start asset protection planning as soon as possible
If you want your asset protection plan to be the most effective you need to put your plan in place long before creditor claims and legal judgments have arisen. Otherwise, your attempts to move your assets will likely appear to be fraudulent. Put another way, if you transfer your assets after a creditor has made a legal claim or a lawsuit has been filed against you, it may be considered a fraudulent transfer. You shouldn’t wait because you may not recognize a potential source of liability early enough to protect your assets from that risk.
Download our FREE estate planning checklist! If you have questions regarding an irrevocable trust, or any other estate planning needs, contact the Northern California Center for Estate Planning and Elder Law for a consultation, either online or by calling us at (916) 437-3500.