Personal FinanceHow To Safeguard Your Assets From Creditors With Trusts

SpenderrificOctober 18, 20215710 min

Are you concerned that you may lose your assets to creditors? You should protect your assets.

Trusts are the most effective asset protection tools in use today. Most people know trusts as estate planning tools used to apportion assets among beneficiaries at death, but trusts can be more than just tools for apportionment. Depending on the type of trust you create, you may also employ them to protect your belongings.

Generally, there are two categories of trusts, revocable and irrevocable trusts.

Revocable trusts (Living trusts)

Living trusts are legal or financial vehicles that hold assets while the owner is alive. They are often used to bypass the probate process. All actions taken in a revocable trust are reversible by the creator of the trust.

When you transfer assets into revocable trusts, you maintain control and ownership over the assets till death. At death, the trustee entrusted with the management of the trust apportions the assets among the beneficiaries.

Revocable trusts have the sole purpose of avoiding probate and do not offer any protection from creditors. They cannot protect your assets because a creditor may force you to transfer the assets out of the trust since you retained control.

Revocable trusts expire once the trustee disburses all assets therein to beneficiaries.

Related post: Wills vs Trusts: What You Need To Know For Estate Planning

Irrevocable trust

Irrevocable trusts are permanent. Once you create them, you can not alter them. If you would like to protect your assets from creditors, this is the tool for you. Some even refer to them as ‘asset protection trusts’.

When planned carefully, you may still be able to benefit from assets transferred to an irrevocable trust without repaying the debt owed.

In all of this, remember that the law does not allow you to set up an irrevocable trust to defraud creditors willfully. If the court believes that you created the trust with the intention of fraud, the trust may get dissolved, and you may suffer harsh penalties. 

You should set up your asset protection strategy long before a creditor comes looking for assets to settle your debt. If you move assets after a creditor sues or when you know you are likely to get sued, you become guilty of deceptive conveyance. 

Waiting till a creditor comes knocking may be too late. Now is the time to protect your assets.

Read more about: Do You Have an Estate Plan? Here is How to Avoid Probate

Asset protection strategies

Apart from irrevocable trusts, there are other ways to protect assets from creditors. They include the following:

Limited Liability Companies (LLC)

The law sees LLCs as separate legal entities or individuals. For this reason, any debt incurred by the LLC cannot extend to the owner. When you set up your business as an LLC, your personal assets are safe from trade creditors. However, you may still be personally liable for loans you guaranteed personally. 

Note that your LLC cannot protect you if you get sued personally. In fact, your LLC can be a valuable asset for settling your debt.

Liability insurance can help minimize the impact of a lawsuit or creditors against your LLC. If your insured company incurs any financial liability from claims or damage to the property of others, the insurance company pays on behalf of your company.

Equity stripping

Equity stripping refers to using specific strategies to make your assets unattractive to creditors. When you give third-party lenders a claim to your property, your creditor may be uninterested in wasting money to take control of the building or asset. They may conclude that coming after you would not be worth their while.

Even after stripping equity from an asset, you can continue to use the property while keeping creditors at bay. Equity stripping will discourage most creditors from attempting to take your asset to settle a debt owed. 

Spousal stripping and HELOC (Home Equity Line of Credit) are the two common types of equity stripping.

  1. Spousal stripping means transferring the ownership of an asset to a spouse. After the transfer, the debtor will file a quitclaim deed, releasing their interest in the property. Quitclaims deeds are employed to transfer ownership of assets in non-sale scenarios, such as assets transfer between family members. The logic behind this is that since your spouse now owns the asset the creditor cannot use it to settle your debt. 
  2. HELOC refers to using the equity in a home as a line of credit. You could liken it to a second mortgage based on the equity in a home. If you are scared of debt from a second mortgage, consider leaving the HELOC unfunded. However, you run the risk of losing your asset if the creditor goes to court. Funding the HELOC gives you more leverage as your new lender will obtain a priority lien. A funded second mortgage reduces your equity in the asset and protects you from the creditor.

The information contained here is not financial advice. You should speak to a professional estate planner, an estate lawyer, or a bankruptcy attorney if you need help with asset protection.

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