Designing a Trust if Asset Protection is Your Goal

When designing a trust with asset protection in mind, it is important to understand the mechanisms that can help shield trust assets from creditors and other claims. While many estate plans include a spendthrift provision, which prevents beneficiaries from transferring their interest in the trust and restricts creditor access, these protections are not absolute. A poorly drafted or administered trust can still expose assets to claims.

So how is it possible to shore up a trust’s asset protection? This article explores proven strategies for maximizing the protective benefits of an asset protection trust in Texas and North Carolina.

Key Strategies for Strengthening Asset Protection in A Trust

1. Appoint an Independent Trustee

The person you select as trustee plays a critical role in trust asset protection. If the beneficiary, a family member, or a friend serves as the trustee, creditors may argue that the trust is a sham—suggesting that the trustee is manipulating distributions to shield assets. This could weaken asset protection significantly.

Appointing an independent trustee, such as a corporate trustee or professional fiduciary, adds credibility and limits claims of impropriety—enhancing the strength of your asset protection trust.

2. Use a Discretionary Distribution Standard

Many trusts include provisions that require the trustee to make distributions for a beneficiary’s health, education, maintenance, or support (HEMS). These mandatory distributions make the trust vulnerable because they create an enforceable right that is vulnerable to creditor claims.

A stronger approach for an asset protection trust is to grant the independent trustee broad discretionary authority. For example, the trust may state that the trustee “may distribute so much of the income or principal as the trustee, in its sole discretion, deems appropriate for any purpose.” Courts are more likely to treat a beneficiary’s interest as speculative under this standard, limiting creditor access, especially if historical distributions are inconsistent and variable.

Does this mean a beneficiary should never serve as trustee of their own trust? Not necessarily. However, if a beneficiary does serve as trustee, distributions should be limited to the HEMS standard (health, education, maintenance, and support). This limitation helps keep the trust assets outside the beneficiary’s estate and reduces exposure of the assets to distributions necessary for the beneficiary’s support.

For added protection, the trust can also mandate that an beneficiary resign and appoint an independent trustee if the beneficiary faces a lawsuit or pending divorce.

3. Maintain an Open Class of Beneficiaries

A trust designed for one beneficiary is more vulnerable to creditor claims than one that benefits multiple individuals. If the class of permissible beneficiaries includes multiple people over current and future generations, then the number of potential beneficiaries is indeterminable. In such trusts, a beneficiary’s interest may not be as vulnerable to creditors’ claims.

For example, rather than simply naming your children as beneficiaries of a trust, you can name your children and their descendants as concurrent beneficiaries, but direct your Trustee to give primary consideration your children’s needs.

4. Create a Trust That Endures Indefinitely

Many trusts terminate at certain milestones, such as when a beneficiary reaches ages 25 or 30. While these provisions ensure that younger beneficiaries do not inherit substantial assets prematurely, they do not provide long-term asset protection. Once assets are distributed, they become vulnerable.

To ensure lasting protection, consider establishing a lifetime asset protection trust. Assets remain within the trust structure and continue to benefit from its legal protections for as long as the trust exists.

6. Administer the Trust Carefully

Even the most well-structured trust can become vulnerable if it is not properly administered. Trustees should:

• Avoid regular, predictable distributions that mimic a salary.
• Ensure that trust assets remain separate from marital property to avoid exposure during divorce proceedings.
• Refrain from direct deposits into joint bank accounts, as commingling could compromise asset protection.
• Maintain records that demonstrate the trustee’s independence and discretion.

Understand State-Specific Spendthrift Exceptions

Some states override spendthrift provisions in certain situations. For example:

• Texas and North Carolina allow courts to order distributions to satisfy child support or maintenance obligations.
• Texas law permits courts to direct child support payments from trust income, even if the trust is purely discretionary.

An experienced estate planning attorney can help you account for these statutory exceptions when designing your trust.

Frequently Asked Questions (FAQs)

What is an asset protection trust?

An asset protection trust is a type of irrevocable trust designed to safeguard assets from creditors, lawsuits, and other financial risks. Proper structuring, trustee selection, and administration are essential to its effectiveness.

What is the best type of trust for asset protection?

A fully discretionary irrevocable trust with an independent trustee provides the strongest protection. When the trustee has sole authority over distributions, it becomes difficult for creditors to access trust assets.

Can a beneficiary serve as trustee of an asset protection trust?

Yes—but with limitations. If a beneficiary also serves as trustee, distributions should be limited to HEMS purposes. The trust should also require appointment of an independent trustee in case of litigation or divorce to preserve asset protection.

Can creditors ever reach assets in a spendthrift trust?

Sometimes. Courts may override spendthrift clauses to enforce obligations such as child support or tax debts. Additionally, if a trust is poorly structured or mismanaged, its protections may fail.

How can an asset protection attorney help?

An asset protection trust attorney can help structure a trust to ensure that it meets legal requirements while maximizing protection against creditors, lawsuits, and other claims. Consulting with an experienced estate palnning attorney is crucial to navigating state-specific laws and implementing strategies tailored to your unique needs.

Conclusion

Designing a trust for asset protection requires careful planning and strategic implementation. By incorporating independent trustees, discretionary distributions, open beneficiary classes, and proper administration, individuals can significantly enhance the protection of trust assets from creditor claims.

If you want to establish a trust that safeguards assets for future generations, consult an experienced Texas and North Carolina estate planning attorney, who can design an estate plan that helps you achieve all your estate planning goals.