In my last blog, I wrote about the importance of proper titling for asset protection. The next most important tool you can use, after you’ve dealt with titling, is a trust. They can be created for a variety of purposes, including protection from creditors, tax minimization, and estate planning purposes. As noted in my previous blog, I am not offering legal advice. This is just general information and you should consult with a qualified attorney to pursue the topic further.
The first trust-like vehicle that many parents consider is a Uniform Gifts to Minors Act (UGMA) account. They’re simple to set up–no special legal work involved–and allow funds that you want to set aside for your children’s use, such as college. Assets in UGMA accounts are distinct from your own, so the income they produce will be taxed at your child’s (presumably very low) marginal tax rate.
UGMA accounts are managed by an independent trustee. Once the child reaches the age of majority (18 in New Jersey), the child has full control of those assets. That might be good news from the child’ perspective, but not so much from yours if circumstances have changed after you set up the account, and you’re not confident that your child will use those funds as you had intended.
UGMA vs. 529
The alternative is a 529 plan, designed specifically with college savings in mind. You control the plan and the funds. You can change who you want to use it for. Although contributions aren’t tax deductible, they can be withdrawn free of federal income tax (and possibly state, too) if used for qualified education expense. They’re better than UGMAs too when colleges estimate your child’s eligibility for financial aid. 529s could be used for other purposes as well, but the tax benefits would disappear: Ineligible withdrawals are subject to income tax plus a 10% penalty on top of that.
A more elaborate trust vehicle you can use to benefit one or more children, while protecting your home, is a trust with lifetime benefits. You transfer ownership of your home to the trust, but retain the ability to live there for the rest of your life. You pay the property tax (and get a tax deduction as you already do) and other operating expenses. But the house cannot be taken away by creditors, and whoever is designated as the trust’s beneficiary ultimately will own the home.
Domestic Asset Protection Trust
A relatively new kind of trust that’s currently allowed in 16 states–and other states are steadily joining the bandwagon–is the domestic asset protection trust, or DAPT.
New Jersey currently doesn’t provide for that specific trust format but does permit something similar. Even if you live in a state that doesn’t currently provide for DAPTs, it’s possible you could take advantage of one in another state, under certain circumstances.
These are known as “self-settled” trusts–essentially meaning that you set them up for your own benefit. Their fundamental purpose, as their name suggests, is asset protection–from creditors, primarily.
People sometimes dream of creating an offshore trust on some sunny Caribbean island for similar purposes. However, those are generally costly to establish and maintain, and typically not practical for folks with less than around $5 million in assets they seek to protect.
I have just scratched the surface of the topic of using trusts for asset protection. Please reach out to us at Beacon if you would like to explore the topic in greater depth.