Do Living Trusts Protect Assets from Creditors?

These trusts are useful for estate planning, but you'll need to take other steps to shield assets.

By , J.D.

If you go to all the trouble of creating a trust to hold your money and other property, surely you're safeguarding those assets, keeping them out of the hands of anyone who might sue you, right? Probably not. It's true that some trusts can protect your family's assets from creditors and claimants. But the garden-variety revocable living trust, commonly used in estate planning, isn't of any use if you're seeking to protect assets.

Revocable Living Trusts

A revocable living trust is the kind of trust a lawyer might recommend when you're writing your will and taking other estate planning steps. Its primary purpose is to save your family the expense and hassle of probate after your death.

Avoiding probate is a worthy goal. Unlike property left through your will, property that you leave to others through a living trust doesn't need probate court approval before it can be passed on to those who inherit it. That means your surviving family members don't need to conduct a probate court proceeding, which typically takes six months to a year and can eat up three to five percent of the amount of your estate. (Probate's complexity and expense depend on where you live and how complicated your financial and family situations are.)

Living trusts have other benefits, too. If you ever become incapacitated, your "successor trustee"—the person you name in the trust document to take over after your death—can step in and manage trust assets. That can be extremely helpful in an emergency or in the case of a serious, chronic illness.

You can make a valid living trust, quickly and easily, with Nolo's Quicken WillMaker & Trust software.

Why Creditors Can Get to Assets in a Revocable Living Trust

Revocable living trusts don't, however, protect your assets from people with legal claims against you. That's because although the trust is a legal entity, for legal purposes you're treated as the owner of the trust assets.

When you set up a typical probate-avoidance revocable living trust, you name yourself as the trustee. That lets you keep complete control over the assets you transfer to the trust. You can put property in the trust, take it out, sell it, or give it away at any time, with no restrictions. As a practical matter, it's still yours.

Another reason the law considers you the owner of trust property is that the trust is revocable—that is, you can revoke it at any time. If you did, the assets would once again be in your name.

While assets are in the trust, any income they generate is taxed on your personal income tax return. The trust isn't a separate tax-paying entity as long as you're alive.

Trusts That Can Protect Assets

Although a simple probate-avoidance trust can't shield assets from creditors, there's a whole industry devoted to asset protection. If you put money in an irrevocable trust—one you don't control and can't revoke—then the money probably won't be considered yours any more, and it won't be available to creditors. Wealthy people who are worried about lawsuits may create very complex trusts, often set up with an offshore trustee. They may also set up limited liability companies or entities called "family limited partnerships."

If you're concerned about creditors and lawsuits, there are also simpler methods to protect assets, such as putting your money in assets that your state protects from creditors. (For example, even if you file for bankruptcy, you can keep the money in your retirement plan accounts; and in some states creditors can't take your house, no matter how much it's worth.) And of course, you can buy insurance.

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