The key benefit of an asset protection trust is the protection it provides against creditors. In addition to this protection, domestic APTs that are created in a state that does not have a state income tax allows the trustor — i.e., the person whose assets are held in the trust — to avoid state income tax.
In addition to protection from creditors, asset protection trusts can shield your assets in the event that you file bankruptcy, get divorced or have a lawsuit filed against you.
What Is an Asset Protection Trust?
An asset protection trust is a trust that has been set up with the specific purpose of protecting the trustor’s assets. Most beneficial to the wealthy, APTs are funded with cash, real estate, business and recreational assets, LLCs, and securities.
Employer-sponsored retirement plans, such as 401(k) plans, and most IRAs are protected under federal law in cases of bankruptcy, so assets held in these qualified accounts are safe without being held in an APT.
These types of trusts are also referred to as “self-settled” trusts or spendthrift trusts, meaning a trust created by an individual for his or her own benefit.
Transferring assets to an asset protection trust is a highly complex strategy that requires the expertise of financial planners, lawyers and insurance brokers. These professionals must consider a number of estate planning factors in addition to the legal protection the APT provides.
These include the tax treatment of the assets held in the trust, their growth potential and future bequests to the trustor’s heirs.
Can You Retire Comfortably?
Domestic and Foreign APTs
There are two types of asset protection trusts: domestic and foreign. Foreign APTs are also referred to as “offshore” APTs because they are often held in offshore accounts.
As of April 2023, there are 20 states that allow asset protection trusts. Trusts are generally governed by the states, so laws vary depending on the state in which a domestic APT is set up.
States that permit APTs include:
- New Hampshire
- Rhode Island
- South Dakota
- West Virginia
The drawbacks to domestic APTs include their being subject to liens and judgments, as well as to bankruptcy and state laws.
Foreign, or offshore, APTs, on the other hand are often held in jurisdictions that do not adhere to U.S. regulations regarding these trusts. Such jurisdictions are referred to as “offshore tax havens” and maintain strict privacy policies.
Regardless of whether the asset protection trust is established within the United States or abroad, it must be an irrevocable trust. This means the assets in the trust are owned by the trustee. As such, the trustor — also known as the settlor or the grantor — has no control over them.
Therefore, if a creditor files a lawsuit against the trustor and wins, the assets in the trust will not be considered part of the trustor’s estate and will be protected from a court order giving the creditor an interest in the assets.
Beware of Foreign Trust Schemes
The IRS warns of foreign asset protection trusts that are part of abusive foreign trust schemes. According to the IRS, abusive trust tax evasion schemes are designed to “hide the true ownership of assets and income or to disguise the substance of transactions” so that they appear to be legitimate trusts. In reality, though, the taxpayer still controls his or her assets, which means they may be seized and sold to satisfy liabilities.
Promoters of these schemes charge up to $70,000 for their foreign packages.
Medicaid Asset Protection Trust
Medicaid sets asset limits to determine an applicant’s eligibility. These limits vary from state to state. A Medicaid asset protection trust allows an applicant to meet these eligibility requirements by reducing the value of his or her assets.
According to the American Council on Aging, “adult children and other relatives can be named as trustees,” but they must follow rules that prohibit them from using trust funds for themselves.
As is the case with other types of asset protection trusts, Medicaid APTs must be irrevocable. Furthermore, the trustor cannot be named as the beneficiary.
Because Medicaid enforces a policy, called the “look-back period,” intended to deter applicants from giving away assets in order to be eligible for the program, applicants must establish a Medicaid APT at least five years prior to applying for benefits.
In addition to preventing the trustor from having to “spend down” assets to qualify for Medicaid, a Medicaid asset protection trust protects the assets from the Medicaid Estate Recovery Program, which is mandatory in all 50 states and exists to recoup the money the state spent on the Medicaid recipient after his or her death.
Having a Medicaid APT ensures that the trustor’s assets will go to his or her beneficiaries and not to the state.