How Judgments Affect Assets in a Trust

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Many people believe that a living trust can protect your assets, but a creditor, a judgment holder, or even your ex-spouse can force you to reach into at least one type of trust to pay off judgments and other debt obligations.

Asset protection is a complicated process, involving a deep analysis of your long-term financial needs and estate planning goals. You must strategically position and re-position your property in order to shield it from creditors' claims, and this begins with an understanding of what different types of living trusts can do.

Revocable Living Trusts

As the name suggests, a revocable living trust is one that the creator—referred to as the grantor or trustmaker in legal terms—can revoke or undo at any time. The trustmaker reserves the right to change the trust's beneficiaries and any other facet of its formation documents. They can take back property and assets that they've funded into the trust.

The trustmaker typically acts as the trustee of this type of trust, managing it and its assets.

You still personally own assets that you've titled in the name of your revocable trust because you retain control over them. You're able to reclaim ownership of them if you see fit. You might appoint someone else to act as trustee or name a successor trustee to take over for you in the event that you should become mentally incapacitated, but you're still the legal owner of the property you've funded into it.

Creditors can take assets you own if they secure a judgment against you from a court, so property funded into a revocable trust is not safe from their grasp if you should default on your repayment terms.

Irrevocable Living Trusts

An irrevocable living trust is much more hands-off. Just as with a revocable trust, the trustmaker would transfer their property into the trust's ownership, but then the trustmaker must step aside. They can't undo the trust. They can't change its terms after they've created it. They cannot act as trustee. Someone else must be appointed to serve in this capacity, either another individual or an institution.

An irrevocable trust moves your assets out of reach regardless of who you might owe money to.

You can't take back property you've funded into this type of trust. It's no longer yours, so it's not available to your creditors under any circumstances. It's safe from estate taxes as well. It doesn't contribute to your taxable estate after your death because you no longer own it.

Testamentary Trusts

A testamentary trust is created under the terms of an individual's last will and testament. It doesn't exist until the trustmaker dies. Their will would include instructions as to what property should move into the trust as part of the probate process, and the executor of their estate or their estate attorney would typically form the trust according to the decedent's wishes.

Unlike revocable and irrevocable trusts, a testamentary trust is subject to probate because that's how it's formed. And because property doesn't transfer into it until the trustmaker's death, it's available to their creditors during their lifetime.

Strategic Asset Protection Planning

Possible asset protection planning measures include the following:

  • Invest in your primary residence if your state offers a homestead exemption prohibiting creditors from forcing the sale of your home to satisfy your debts.
  • Buy life insurance that accumulates a cash value.
  • Fund retirement accounts, such as IRAs and 401ks. ERISA-qualified retirement accounts are typically safe from creditors under federal law.
  • Purchase annuities.
  • Set up a family limited liability company or a family limited partnership, and transfer ownership of assets into these entities.

The Bottom Line

A revocable living trust can't reliably protect your assets, although an irrevocable trust can, but forming an irrevocable trust means giving up control and ownership of your assets forever. Consider a multi-pronged advanced estate plan instead that employs combinations of these strategies to achieve comprehensive asset protection planning over the long haul.

NOTE: The information contained in this article isn't legal advice and it's not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to federal law. Please consult with an financial professional or an attorney
for current advice.