Asset Protection 101: Trusts

Part 2

In part two of this ongoing series on asset protection essentials, we further explore the importance of trusts as a means for protecting your wealth and shielding you and your loved ones from liability. 

Asset protection is an important part of managing your wealth and shielding you and your loved ones from liability. In this ongoing series, the legal team at Counxel will go over some of the strongest types of trusts. Part one introduced the self-settled asset protection trust as a means of protecting your assets. Here, we’ll discuss some techniques to strengthen that trust as well as the pros and cons to know before establishing one of your own.

Structuring a Domestic Self-Settled Asset Protection Trust

Domestic self-settled asset protection trusts are attractive for the lower costs, time, and effort associated with creation and maintenance. The Internal Revenue Service’s tax reporting requirements alone make foreign self-settled asset protection trusts unappealing to many clients, which spurs them to easier forms of asset protection, including the domestic options.

Every state treats self-settled asset protection trusts differently, so structuring the trust correctly depends heavily on the laws in your area. Nevertheless, there are some general principles of trust formation and maintenance that hold true no matter where in the United States you’re located.

The first and most important challenge for a client is ensuring that the self-settled asset protection trust will be considered valid by your state’s courts. A worst-case scenario would be operating as though a trust was correctly formed and properly insulated, only to have a court invalidate the entire process after the fact. 

To strengthen the chance that a state will uphold the validity of a domestic self-settled asset protection trust, the settlor needs to tie the trust to the designated state through a series of both legal and procedural maneuvers. The settlor will need to deposit at least some of the assets in the state and appoint a trustee who resides there as initial steps. If the trust owns real property, that property should also be in-state. Ideally, the trust will retain local counsel in that state and the trust’s beneficiaries will be residents of that state as well. The trustee can prepare income tax returns with complete discretion over distributions.

When One Trust is Not Enough

For some clients, an additional measure of protection would be creating a limited liability company (LLC) or a third-party settled trust. The liability shield of the assets in an LLC or trust will provide a second wall in case the self-settled asset protection trust looks weak on paper or is in jeopardy.

The Pros and Cons of a Self-Settled Asset Protection Trust

Part one of Counxel’s series on trusts covered some of the advantages and disadvantages of self-settled asset protection in both foreign and domestic trusts. Here, we’ll examine the pros and cons of this type of trust focusing on its internal governance and control.

With all this talk about how great a self-settled asset protection trust is, clients should be aware that the trust’s internal weakness is ultimately the trustee. It can be expensive finding and appointing a resident trustee, and it’s crucial the trustee remains loyal to your interests. In a doomsday scenario, the trustee may go against your wishes, adding additional expense and stress fixing the problem.

Other potential downsides include the time and money involved in structuring the trust to ensure its validity in a designated state. The trust may also be subject to conflicts of law disputes if the trust is challenged in court.

Despite these inherent risks, the strong degree of protection makes self-settled asset protection trusts popular in the world of asset protection. Apart from the benefits of protection from creditors and reduced tax liability, some states offer significant degrees of control over the trust’s governance. Even better, the assets inside the trust are accessible in an emergency.

When is a Trust Wrong for Me?

There are several instances when a self-settled asset protection trust might be the wrong choice for a client. When the transfer of assets become voided as fraudulent transfers, when the settlor cannot remain solvent after creating the trust, or when a conflict of laws may undermine the trust in the long run are all potential reasons this might not be the right choice for your estate.

 

Finally, there are several additional considerations for domestic trusts where the otherwise strong wall surrounding your assets can be perforated by state law. States will sometimes provide legal exceptions, and creditors may be able to reach your assets in cases of child support, alimony, tortfeasance, and divorce. Clients should consult with an attorney to carefully consider whether a foreign or domestic trust is appropriate, or whether creating a self-settled asset protection trust is the right move at all. At Counxel Law Firm we take the nuances of each individual estate into account to best advise you on next steps.

Counxel Legal Firm

There are many ways to protect your assets, but trusts remain one of the most reliable and popular choices. A self-settled asset protection trust in particular provides powerful safeguards, especially when formed in certain foreign jurisdictions. Consult with the attorneys at Counxel Legal Firm today to decide whether a trust will best protect your wealth.

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