Designing a Trust if Asset Protection is Your Goal

When designing a trust with asset protection in mind, it is crucial to understand the mechanisms that can help shield trust assets from creditors and other claims. Most estate planning documents include a spendthrift provision , which prevents beneficiaries from transferring their interest in the trust and restricts creditors from accessing those assets. However, spendthrift protections are not absolute. Depending on the trust’s provisions and administration, creditors may still find ways to reach trust assets.

So how is it possible to shore up a trust’s asset protection? This article explores a few strategies that can maximize asset protection benefits of a trust.

Key Strategies for Strengthening Asset Protection in A Trust

1. Appoint an Independent Trustee

The choice of 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.

Having an independent trustee—such as a corporate trustee or professional fiduciary—removes the suspicion of impropriety.

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. If a beneficiary has an enforceable right to distributions, creditors can potentially access those funds.

A stronger alternative is to grant an independent trustee broad discretionary authority over distributions. Instead of stating that the trustee “shall make distributions,” the trust could specify that the “Independent Trustee may distribute so much of the income and principal as the Independent Trustee, in its sole discretion, determines for any purpose.” Courts have ruled that such language makes the beneficiary’s interest speculative and not subject to creditor claims, especially if historical distributions are inconsistent and variable.

Does this mean a beneficiary should never serve as trustee of his or her trust? Not necessarily. However, However, if a beneficiary serves as a trustee, distributions should remain limited to the HEMS standard to keeps 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. 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.

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.

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 a distribution is made, the assets lose their trust protections and become vulnerable.

For lifelong asset protection, a trust should be discretionary and designed to last a beneficiary’s lifetime. This ensures that assets remain protected as long as they are held in trust.

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.

Be Aware of State-Specific Spendthrift Exceptions

Some states impose statutory exceptions to spendthrift protections. 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.

Understanding these legal nuances is essential when designing a trust for maximum asset protection.

Frequently Asked Questions (FAQs)

What is the best type of trust for asset protection?

A discretionary trust with an independent trustee provides the highest level of protection. This type of trust gives the trustee full control over distributions, making it difficult for creditors to claim trust assets.

Can a beneficiary serve as a trustee and still have asset protection?

Yes, but with limitations. If a beneficiary is also the trustee, distributions should be restricted to the HEMS standard (health, education, maintenance, and support) to maintain protection. Additionally, the trust should require an independent trustee to take over in case of litigation or divorce.

Can creditors ever access assets in a spendthrift trust?

In some cases, yes. Certain state laws allow courts to override spendthrift provisions for obligations like child support, alimony, and tax debts. Additionally, if a trust is poorly structured or administered improperly, creditors may find ways to access the assets.

How do I ensure my will is valid in Texas or North Carolina?

Each state has specific requirements for a valid will. To ensure your will is legally enforceable, review our guides on Valid Texas Will and Valid North Carolina Will. Consulting an attorney familiar with estate laws in your state is highly recommended.

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.