Living Trust Protection From Creditors

By Maggie Lourdes

A living trust is an estate planning tool that can save time and money by bypassing the probate process after the trust maker dies. Unlike a will, a trust does not require a probate court's approval or administration. Living trusts are so called because they take effect during the maker's lifetime and can be changed or revoked at any time before his death. Besides skipping probate, living trusts can protect beneficiaries from creditors. Spendthrift clauses, as the name suggests, protect beneficiaries who spend money irresponsibly and face bill collectors. Spendthrift clauses also protect beneficiaries who accumulate bills for unavoidable reasons like medical problems or job loss.

Spendthrifts Protect Beneficiaries

A spendthrift clause can prevent a beneficiary's creditors from reaching her living trust interests. Spendthrift clauses do not protect assets once they are released from trust and paid to beneficiaries. For example, Bob leaves a house in his living trust for Jane. Jane's bill collectors generally cannot attach the house while it remains in the trust's name. However, if the house is sold and the proceeds deposited into Jane's personal bank account, bill collectors may reach them.

Spendthrifts Prevent Assignments

Spendthrift clauses generally prohibit a beneficiary from assigning his interests in trust assets. For example, Mary leaves her summer cabin in her living trust to Bob. Bob cannot use the cabin as collateral to buy a new car by pledging, assigning or granting a lien against it. Preventing a beneficiary's control over trust assets prevents his creditors from seizing them to satisfy his debts.

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Trustees Have Discretion

A trustee must follow a living trust's directions. However, spendthrift clauses generally give a trustee discretion to shield assets from creditors. For example, John's living trust states $1,000 should be paid to Sue each month. The payments are attachable by Sue's creditors once they are paid to her. The trustee may suspend payments, protecting the money by keeping it in the trust, while Sue negotiates a settlement with her creditors.

Spendthrifts Have Limitations

Spendthrift clauses do have limitations. For example, they generally do not protect a beneficiary's trust assets from overdue child support, alimony or delinquent tax bills. Spendthrift clauses typically do not protect the person who makes the living trust from his creditors. Each state has its own laws relating to the legalities of spendthrift clauses. Carefully research the law of your state or consult a trust expert with specific questions about trust protection options.

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Can an Irrevocable Trust Be Pierced?

When you create an irrevocable trust, you surrenders ownership over the trust assets; you cannot unilaterally regain control of the property. As a result, your creditors cannot get to the assets to satisfy the your debts. Irrevocable trusts are also generally structured to prevent a beneficiary’s creditors from gaining the trust’s assets to settle his debts. Although laws vary among states, there are cases in which a creditor can “pierce” the trust shield to obtain trust assets as a means of settling outstanding debts.

A Revocable Trust & Asset Protection

Living trusts are estate planning tools used for transferring property at death. These trusts go into effect during your lifetime and allow quick distribution of assets after your death by avoiding the cumbersome and public probate process. Some trusts offer asset protection in a variety of ways. A revocable trust does not protect assets from your creditors, but when those assets pass to your beneficiary, they can be protected.

Removing Real Estate From a Revocable Trust

Revocable trusts are often implemented to avoid probate. A trust's maker, or grantor, retains the power to fully revoke or amend a revocable trust. A trust is governed by its terms and adding or removing real estate from a trust is a power that is usually specifically listed. If a trust lacks this provision, an amendment may be legally required before real estate can be added or removed. Trust requirements may vary, depending on state law.

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