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Do Living Trusts Protect Assets from Creditors?

Living trusts are useful for estate planning, but if you have debts or want to shield assets from creditors, you'll need to take other steps.

By , J.D.
Nolo

Does a revocable trust protect assets from creditors or lawsuits? 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? Unfortunately, probably not. It's true that some trusts can protect your family's assets from creditors and lawsuits. But the garden-variety revocable living trust, commonly used in estate planning because it provides certain benefits, isn't of any use if you're seeking to protect assets from creditors.

The Benefits of 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 whose costs can really add up. (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 legally valid living trust, quickly and easily, with Nolo's Quicken WillMaker & Trust.

Why Creditors Can Go After 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 liability purposes you're treated as the owner of the trust assets.

When you set up a typical 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 (undo it) at any time. If you did, the assets would once again be in your name as an individual.

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: Certain Irrevocable Trusts

Although a simple probate-avoidance trust can't shield assets from creditors, there's a whole industry devoted to asset protection. If you want to protect assets with a trust, some irrevocable trusts will do the trick.

When 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 anymore, and it won't be available to creditors. You would typically name other beneficiaries (such as your spouse, children, or other loved ones) to receive the money in the trust.

The drawback, of course, is that you give up ownership of and control over this money. You can't decide later that you want the money back. In general, you can't keep the money or take income from the trust and keep that money away from creditors—you can't have it both ways.

That said, there are a few exceptions in some states. And wealthy people who are worried about lawsuits may create very complex trusts, often set up with an offshore trustee, or attempt other workarounds.

You'll Need a Lawyer to Make a Trust That Protects Assets

Unlike simple revocable living trusts, irrevocable trusts are complex, and you will need an experienced estate planning lawyer to create one that fits your situation. If you have significant debts or are worried about lawsuits, discuss these concerns with a lawyer to find out your options. In addition, state laws vary, so you'll want to work with a lawyer familiar with the laws in your state.

Assets That Are Protected From Lawsuits and Creditors in Other Ways

If you're concerned about creditors and lawsuits, there are also other 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.

To limit your exposure to lawsuits, you can also set up limited liability companies or entities called "family limited partnerships."

And if you're worried about leaving money to a loved one who has major debts or might squander an inheritance, you can consider a special spendthrift trust.

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