Asset Protection Trusts (APTs) offer individuals a powerful tool to safeguard their wealth from potential creditors and legal claims. In this guide, we will explore the fundamental components of APTs, the roles of key participants such as the settlor, trustee, and beneficiary, and discuss optimal ways to set up your APT, as well as pitfalls to avoid.
Before we begin discussing how asset protection trusts work, let’s review some basic elements of trusts in general. Every trust needs a settlor (also called “grantor”), a trustee, a beneficiary, and the trust property. Let’s examine each of these in detail to see how they apply in the context of APTs.
In the case of self-settled APTs, the settlor is also one of the beneficiaries, meaning they retain the potential to benefit from the assets held in the trust while still seeking protection from potential creditors. In a third-party APT, the settlor is typically someone who wishes to provide asset protection for the beneficiaries but does not intend to benefit from the trust's assets themselves directly. This could be a parent, grandparent, or other individual seeking to shield assets for the benefit of future generations or specific beneficiaries.
In order to create an effective APT, there are a number of factors to consider.
Level of control: the more control you retain over the trust and its assets, the more likely a court will allow your creditors to bypass the trust and satisfy their claims against its income and assets. For these reasons, it is important to structure your APT as an irrevocable trust, which means that once the trust is created, the settlor cannot modify or amend the terms of the trust, or access its funds. As we will discuss in more detail below
Jurisdictional considerations. Broadly speaking, you can establish your APT in jurisdictions you do not reside in. Because there are very significant jurisdictional differences in requirements for APTs, and what claims may be shielded from which creditor under various circumstances, it is essential to review the laws of each jurisdiction before deciding which one to have your trust is based on your specific needs and intentions for the trust. Note that there are some states that do not even recognize the validity of APTs, or only recognize them foe extremely limited purposes.
Nature and extent of the trustee’s discretion: Generally speaking, trust distributions may be either discretionary, meaning the trustee possesses the authority to decide if, when, and how much to distribute to beneficiaries, or fixed, where distributions are set at specific amounts or intervals as dictated in the trust document. With APTs, distributions should be discretionary since it ensures a higher level of asset protection for the trust's assets because creditors are less likely to be able to claim distributions from a discretionary trust.
At this point, you may be wondering what the point of an APT is in the first place if you must relinquish control over the trust’s funds such that all disbursements are subject to the trustee’s discretion. The answer lies in the nature and scope of the trustee’s discretion when it comes to APTs.
Essentially, the trustee’s discretion is not absolute and exists within certain parameters. Specifically, within the trustee's discretion, funds from the trust can be used for various genuine needs of the beneficiary. Examples include:
However, this can give rise to another issue: what if the trustee refuses to exercise its discretion as appropriate? Given the irrevocable nature of APTs, and your relinquishment of control, what recourse would you have in such situations? The answer lies in the appointment of a protector.
The role of a protector in an APT is to oversee and ensure that the trust operates in accordance with its intended purpose and that the trustee exercises discretion appropriately. If the trustee refuses to exercise its discretion as appropriate, a protector can have the power to remove and appoint trustees, to approve or disapprove distributions, and make other decisions about the trust.
While APTs offer asset protection to some extent, public policy considerations dictate certain debts that remain outside the trust's protections. These include:
There are some conditions under which a court can decide you are “abusing” the form of your trust by using it as a facade or a mere formality, and therefore it is proper to pierce the veil of the trust so that your creditors can access its assets. Factors that might lead to this include:
As you can see, setting up an APT has many steps and details to consider. An attorney with experience in Trusts & Estates law can help you correctly set up the trust. Through AAL’s directory, you can find experienced attorneys who can guide you through the process, ensuring your assets are protected as intended.