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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.

Components of an APT

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.

  1. The Settlor: The settlor, also referred to as a “grantor,” is the person who creates the trust and transfers the assets into it.   
  2. The Trustee: The individual or entity responsible for managing the trust’s assets. APTs, Because the trustee will have the discretion over how the trusts are managed and distributions are made to the beneficiaries (within certain limits), the trustee is usually a trusted financial institution or wealth management firm.    
  3. The Beneficiary: The person or entity who benefits from the trust.  
  4. Trust Property: This refers to the assets placed in the trust. There are many types of assets that can be placed in a trust, including bank deposits, stocks and bonds, business ownership interests, and real estate holdings.

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.

How to form an effective APT

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.  

How to access your APT’s funds or receive distributions from it

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:

  • Medical expenses such as costs related to surgeries, treatments, medications, or any health-related emergencies.
  • Educational expenses such as tuition fees, books, accommodation, and other related costs for schooling or higher education.
  • Living expenses for basic necessities such as rent, utilities, groceries, and transportation.
  • Certain special occasions, including events like weddings, childbirth, or other significant life milestones.

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.

Debts an APT Cannot Shield You From

While APTs offer asset protection to some extent, public policy considerations dictate certain debts that remain outside the trust's protections. These include:

  • Existing debts: Claims that could have been satisfied from your assets at the time you transferred them to the trust. This means that if you had outstanding debts before establishing the trust, transferring assets to the trust won't protect those assets from those specific creditors. Under certain circumstances, courts will look back to the period before the trust was created and consider whether the settlor transferred assets to the trust with the intent to defraud creditors, in which case the creditors may be able to reach the APT’s assets.
  • Child support and alimony: Legal obligations, such as child support and alimony, take precedence over trust protections.
  • Tax liens, debts, and other outstanding obligations: These are claims made by governmental agencies for unpaid taxes. If you owe back taxes, the government can place a lien on your assets, including those in a trust. This means that the assets within the trust can be used to satisfy your tax obligations.
  • Fines and other regulatory penalties: If you've been fined or penalized by governmental authorities, these debts often cannot be evaded using a trust. For instance, if you've been fined for regulatory violations in a business context or owe restitution due to a legal judgment, these debts often take precedence over trust protections.

Losing the Protections of Your Trust (Piercing the Veil)

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:

  • Bad faith transfers: If assets were transferred to the trust with the primary intention of defrauding creditors, a court might deem such transfers as void. For example, if someone facing a large lawsuit suddenly transfers a significant portion of their wealth into a trust, the court might view this as an attempt to evade legitimate claims.
  • Retaining excessive control: If the settlor retains too much control over the trust's assets, it might be viewed as a personal asset rather than a trust asset. For example, suppose the settlor has the ability to withdraw funds at will or dictate investment decisions without any trustee oversight. In that case, the trust might be seen as an extension of the settlor's personal finances.
  • Commingling of assets: Mixing trust assets with personal assets can jeopardize your APT’s integrity. For example, if the settlor uses a trust bank account for personal expenses or deposits personal funds into the trust account without clear delineation, it can blur the lines between personal and trust assets, making it easier for creditors to challenge the trust's validity.

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.

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