How Irrevocable Trusts Protect Assets from Creditors
An irrevocable trust protects assets from creditors by moving them out of your name and into a trust you cannot revoke or control. Because you no longer own the property, a creditor who wins a judgment against you generally cannot pursue or seize it.
If the trust also includes a spendthrift clause and gives the trustee discretion over distributions, a beneficiary's creditors usually cannot reach the assets before they are paid out. That protection, however, depends on careful drafting and good timing.
At Sanders & Sanders, Attorneys at Law, our attorneys often meet clients who have worked for decades to build a home, savings, or a family business and worry that a lawsuit, unpaid debt, or the cost of long-term care could wipe it out. We can explain how irrevocable trusts can protect your assets, where that protection ends under Maryland law, and who benefits most. Contact us to schedule a consultation.
Why Does Giving Up Ownership Create Protection?
A trust is a legal arrangement in which one person, the grantor, transfers property to a trustee, who manages it for the benefit of one or more beneficiaries. The key question for creditor protection is whether the grantor can take the property back.
With a revocable living trust, you can amend or cancel the trust at any time, so the law views those assets as still part of your estate. If creditors pursue you, they can pursue those assets just as easily as a personal bank account.
An irrevocable trust works differently. Once you fund it, you generally cannot change its terms, reclaim the property, or direct how it is spent. An independent trustee will manage the trust, which becomes the legal owner. A creditor pursuing you personally has no claim against property you no longer own.
In short, the protection comes from the very feature many people find intimidating: giving up control. However, you must properly retitle any real estate, investment accounts, and life insurance policies in the trust's name. An unfunded trust does not provide any protection.
How Do Spendthrift and Discretionary Provisions Protect Your Beneficiaries?
An irrevocable trust can also protect the people you leave assets to. Two drafting tools do most of this work: spendthrift provisions and discretionary distribution.
A spendthrift provision prevents a beneficiary from selling, pledging, or assigning their future trust interest. It also bars the beneficiary's creditors from seizing that interest while it remains in the trust. Maryland courts have long enforced these clauses. In Duvall v. McGee, Maryland's highest court held that even a tort-judgment creditor could not invade a spendthrift trust to collect.
Discretionary distribution gives the trustee the power to decide whether, when, and how much of the trust property to distribute. Because the beneficiary has no fixed right to payments, a creditor has nothing definite to collect against.
Together, these provisions can protect your heirs and beneficiaries during a divorce, business failure, lawsuit, or financial trouble. However, once the property is paid out to the beneficiary, trust protection is typically lost.
Where Does Trust Protection End?
Irrevocable trusts are powerful estate planning tools and offer significant benefits and protection against creditors. However, they are not a cure for debts you already owe. Several limits apply.
Fraudulent transfers: If you move assets into a trust to avoid an existing creditor or a lawsuit you can see coming, a court can undo the transfer under Maryland's fraudulent conveyance laws. The courts will examine transfers made after a claim arises or that leave you unable to pay your debts. In bankruptcy, a trustee can reach back as far as ten years to unwind transfers to self-settled trusts that were made with intent to defraud.
Self-settled trusts: Neither Maryland nor the District of Columbia have adopted a domestic asset protection trust statute. Generally, if you create a trust and remain a beneficiary, your creditors can reach whatever the trustee could distribute to you.
Support and government claims: Maryland courts have allowed claims for child support, alimony, and certain taxes to reach trust distributions despite a spendthrift clause.
Who Benefits the Most From an Irrevocable Trust?
Irrevocable trusts can be useful protection strategies for anyone. However, they are especially valuable for certain types of professionals and situations, such as:
Physicians, contractors, and business owners who face a higher risk of lawsuits
Parents who want to protect an inheritance from a child's divorce, debts, or poor spending habits
Families caring for a loved one with special needs who must preserve eligibility for public benefits
Older adults planning for the cost of nursing home care
A properly structured Medicaid asset protection trust can help preserve your home and savings while you qualify for long-term care benefits. Medicaid applies a five-year look-back period to asset transfers, so these trusts work best when created well before care is needed.
Contact Our Experienced Maryland Estate Planning Attorneys at Sanders & Sanders
An irrevocable trust can keep your assets out of creditors' reach, but only if you draft it carefully and fund it at the right time. A single misstep can leave your family exposed. At Sanders & Sanders, Attorneys at Law, our attorneys, L. Norman Sanders and Lisa Smith Sanders, help individuals and families design estate plans that protect their wealth and legacy.
From our office in Upper Marlboro, we serve clients throughout Clinton, Bowie, Fort Washington, Largo, Maryland, and Washington, D.C. We take the time to understand your goals and explain your options in plain language. Our goal is to tailor your trust to your family's needs. To learn whether an irrevocable trust is right for you, contact us to schedule a consultation.