Making a Trust Lawsuit-Proof

An irrevocable trust is required to shelter assets from creditors and a trust that includes the correct protective provisions can successfully render the trust's assets from its beneficiaries' creditors.

All trusts are either known as intervivos or testamentary. An intervivos trust is created and funded during the lifetime of the grantor and one that is funded at the time of death of the grantor is known as testamentary. You would usually create it in your last will or living trust. During your lifetime, your assets remain in your name and would be unprotected against your creditors, unless they have otherwise been sheltered.

Trusts are also revocable or irrevocable. As suggested by its title, an irrevocable trust cannot be modified. Any testamentary trust is irrevocable once the grantor dies. It is important to distinguish a revocable trust from an irrevocable trust because a revocable trust does not provide the same protection as an irrevocable trust, which must be funded intervivos to be effective.

A serious disadvantage in using an irrevocable intervivos trust for protection is that once the trust is established and funded it cannot be modified or property transferred to it cannot be reclaimed, in which case ownership and control over trust assets is completely lost. For this reason, irrevocable intervivos trusts are seldom used for Asset Protection, although they can be effective for estate planning.

A revocable trust will not protect assets because creditors can step into the position of the grantor and revoke the trust. Assets titled to a revocable living trust are vulnerable to present and future lawsuits, but will still dismiss an estate from the probate process. An irrevocable trust (or another protective entity) is preferred for Asset Protection because an irrevocable trust prohibits any modification by creditors to claim or reclaim its assets. An irrevocable trust provides protection only if it is funded and until assets are transferred to the trust, they can be claimed by creditors.

Other limitations to trusts that must be considered include the fact that a trust cannot be settled for the sole benefit of the grantor. For optimal protection the grantor should have no beneficial interest in the trust; however it is possible to retain income rights based on a reasonable and ascertainable standard of need for medical expenses and other reasons. A number of states disallow self-settled trusts for asset protection and grantor can neither control the trust nor have any beneficial rights.

Assets that are fraudulently transferred to a trust can be recovered by present creditors and an irrevocable trust can protect only against future creditors. Assets should be transferred to an irrevocable trust only when the grantor is confident that they have no present creditors. Knowing for sure that no creditors exist can be difficult, so if there is any likelihood of a creditor the irrevocable trust should not be used as a present creditor can successfully recover assets from the trust because the transfer was without consideration.

For the most effective protection from a trust it is essential to use the irrevocable trust and relinquish control and beneficial interest and ensure that no fraudulent transfers take place. It is not unusual for a trust to be set aside by a court if the trust is determined to have been formed unlawfully.

For Asset Protection, the irrevocable trust imposes strict rules that many wealthy individuals want to avoid. Accordingly, an irrevocable trust makes sense when the grantor would soon gift the assets to their beneficiaries anyways and when there is no foreseeable need for the assets to provide financial security to the grantor.

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