Asset Protection Trust - What is it? How does it work?
To begin with, a trust is a merely a type of contract or agreement. There are usually three main parties associated with the agreement.
- Settlor. The settlor is the one who creates the trust. The settlor, also referred to as the “grantor’ or “trustor,” usually contributes the initial assets into the trust. Most often the settlor is the person requests that the trust be drafted.
- Trustee. The trustee holds property for the benefit of another. This person or company is legally required to perform his duty under the terms of the trust agreement.
- Beneficiary. The beneficiary is a natural person or legal entity who is generally entitled to the proceeds of the trust. Beneficiaries may the Settlor, his or her spouse, children and/or grandchildren.
An “Asset Protection Trust” adds verbiage to the agreement intended to shelter the trust assets from being seized by legal enemies of the settlor and/or beneficiaries. (Since the trustee is merely holding the assets for the benefit of another person, a lawsuit against the trustee does not generally endanger trust assets.) There are a number of provisions that add the financial-fortress element to the contract.
First, the trust contract includes transferring assets from the settlor to the trust under the terms of the agreement. For extra peace of mind, one wise strategy is for the trust to own 100% of a US or foreign limited liability company (LLC). Initially, the Settlor is the manager of the LLC and signature on the LLC bank account. In this scenario, the LLC has a bank account and the trust either has no bank account or has one with a relatively small account balance. This arrangement gives the Settlor control of the assets inside the trust until trust assets are threatened. When the assets are at risk it is in the Settlor’s best interest to hand the reigns to the trustee. Once the reigns are handed to the trustee, the settlor can no longer comply with court orders to release the funds.
Some people who don’t have experience type of setup may be concerned that the trustee could run off with their money. That is best answered with another question. “Would you rather have a 100% chance of your money being taken by the courts? Or would you rather have a licensed, bonded trustee who has never taken a client’s money do what you have paid them to do - protect your money?" The only time the trustee steps is when trust assets would be taken by court-order. Plus, it is best to choose a trustee company that is bonded by an insurance company and in a very reputable jurisdiction such as the Cook Islands.
You may have heard of Grantor and Non-Grantor Trusts. In grantor trusts, the grantor keeps elements of control over the trust and its assets. This includes the right to revoke (change or end) the trust. The grantor (settlor) may also be the trustee and beneficiary of its assets and income. In this setup, the income and expenses are reported on the grantor’s income tax returns The trust does not have a separate tax ID number and does not have to file its own tax returns. The income and deductions flow through to grantor’s personal 1040 form, for example.
With a non-grantor trust, the grantor gives up the right, title and interest to the trust assets. The trustee is entrusted with the holdings. The non-grantor arrangement does not generally allow the grantor to be a trustee or beneficiary.
The grantor trust becomes a non-grantor type upon the grantors’ death. At that point, one needs to obtain a tax ID number. Then, on the December 31 of the year in which the grantor dies, the administrator is required to file a 1041 tax form.
What does a revocable and irrevocable trust mean? Revocable means that the trust can be changed or terminated by the Settlor. So, assets are transferred to the trust with strings attached. With this type of trust, the grantor, trustee and beneficiary are often the same person. This type of trust does not provide asset protection because if the settlor is sued and loses the lawsuit, the one who won the lawsuit will be able to step into the Settlor’s shoes and change the document so that he is the beneficiary of the trust assets. Living trusts, used mainly to avoid probate upon death, are almost always revocable.
With an irrevocable trust, the grantor (who moved the original assets into the trust) gives up control of the trust. The trustee uses his best judgment to manages the assets held therein. It is the duty of the trustee to protect trust property. The trustee is to invest prudently and does not engage in inappropriate self-dealing. The courts frown on trustees who do not act in the best interest of the beneficiaries.
The irrevocable trust can provide substantial asset protection. Because the grantor is not able to change the trust, the person who has sued and has been awarded a judgment against the grantor is not able to step into his shoes and make changes for his own benefit. The irrevocable trust can protect money and property from lawsuits, avoid probate, lower or avoid estate taxes, and shelter assets in order to qualify for government assistance for a nursing home.
Because a local judge has jurisdiction over local trusts, the strongest fortress is provided by an international trust. In our experience, the strongest protection is offered in the following jurisdictions in the following order:
- Cook Islands
- Nevis
- Belize
The ideal situation is where a Cook Islands Trust owns a Nevis LLC that, in turn, holds one or more international bank accounts. The accounts are best established in very safe jurisdictions such as Switzerland. We know of no case in recent history where a client has lost a dime out of this type of trust setup. This legal financial fortress is truly the crème-de-la-crème of asset protection.