An asset protection trust is a legal arrangement set up to protect the trust's contents from taxes, debtors, lawsuits, divorce, and even bankruptcy. A person who creates this type of trust seeks to safeguard the trust’s assets for the sake of the trust’s beneficiaries. A trust can be created for asset protection if it is a discretionary trust, which means its beneficiary’s benefit from the trust is not fixed. Instead, the person who manages the trust has the discretion to decide how much to pay to each of the beneficiaries and when to distribute.
Learning what a trust is can prove helpful in understanding how an asset protection trust works. Basically, a trust is a legal arrangement a grantor, a person who creates a trust, forms. He chooses a trustee, a person who takes over the control and management of the assets placed in the trust. The trustee manages the assets on behalf of the person or people who will benefit from the trust, not for the benefit of the grantor. A person who benefits from the trust is referred to as its beneficiary.
Typically, an asset protection trust includes a spendthrift clause. This clause helps protect the trust not only from people and creditors who might try to seize its assets, but also from the irresponsibility of the beneficiary. The reason an asset protection trust may work so well is because neither the grantor nor the beneficiary owns the assets. The trust becomes a legal entity and technically owns the assets.
A spendthrift clause allows a trustee to decide when and how much of a trust’s assets a beneficiary can use. For example, a beneficiary may be known for compulsive gambling, so a grantor may have a spendthrift clause included in his trust. This means the beneficiary cannot simply use the trust’s assets to support his gambling habits. Instead, he would have to use whatever income the trustee provided for him. If he spent that amount irresponsibly, he would not be able to receive additional income from the trust without the trustee’s permission.
A grantor who sets up an asset protection trust can also shield the trust’s assets in the event of bad business deals, accidents, and even bad marriages. If a beneficiary starts a business and fails to pay his business debts, for example, his creditors cannot seize any of the trust’s assets to recoup their money. Likewise, the assets of such a trust are often invulnerable to divorce. The beneficiary of an asset protection trust cannot lose any of the trust’s assets in a divorce proceeding. Any asset that has been distributed to a beneficiary receives no such protection, however, as it is no longer part of the trust.