Do you remember the expression, “All that glitters is not gold?” There’s a lot of wisdom in that.
In my last blog, I mentioned a potential asset protection vehicle called a domestic asset protection trust, or DAPT. Its purpose, as its name suggests, is to protect your assets from claims that might arise out of a number of circumstances. Example: litigation following a serious automobile accident.
While asset protection is a critical piece of a long-term wealth accumulation plan, and there are a variety of trusts that can be used to help you achieve that goal, the DAPT may not be one of them. More on that later. (Note: The information provided here is not intended as legal advice, but simply food for thought. Consult a qualified attorney when you’re ready to look closely at various trust options.)
Timing Is Everything
But first, the most important thing to know about asset protection is that you need to put your protection strategy in place BEFORE you need it. Sounds basic, right? Yet I’ve heard from people who thought they could create and put assets into a trust immediately after incurring a potentially bankrupting liability. No can do: If the assets were not in an irrevocable trust when the incident occurred, you can’t shelter them retroactively–not even for a day. It would be like trying to buy a life insurance policy after the insured person died. Good luck with that.
What kind of trust might meet your needs? Notice the term “irrevocable” used above. Only an irrevocable trust can protect assets from claims. That kind of trust, as its name suggests, cannot be un-done, and you no longer own the assets you put in the trust. Therefore they are not available to help settle a claim against you. An irrevocable trust must be controlled by an independent trustee.
That doesn’t mean you can’t still benefit from assets in the trust. For example, you could move your home to an irrevocable “grantor” trust (with you being the grantor–the giver of the assets to the trust) while continuing to live in it until you die and the home’s ownership transfers, for example, to your children.
The property is removed from your estate when the trust term ends, so that if you’re lucky enough to have a large estate, it won’t add to your estate tax liability.
Or, if the trust document is written to provide for this, the trustee could sell the home and the proceeds could be redeployed to purchase another (perhaps smaller) home held in the trust that you could occupy.
Irrevocable trusts can be used for lots of other purposes, such as owning life insurance. The point is, as long as you are willing to give up control, there are liability protection and possibly tax benefits.
But what about the DAPT? Trust law is generally controlled by states, and currently only 17 states allow for DAPTs. What sets them apart from other irrevocable trusts is that the person who sets up the trust can also be its beneficiary. Before the advent of the DAPT, the only way you could accomplish that was to set up a trust offshore.
Unless you live in one of the 17 states that provide for DAPTs (and New Jersey doesn’t happen to be one of them), it’s a dicey proposition as to whether it would afford you the asset protection you seek. And even if you do live in a DAPT-friendly state, it’s not entirely clear how a DAPT would withstand litigation originating from a federal court. Also, the DAPT’s trustee must be based in one of those 17 states.
So, the DAPT could be one of those glittery objects that look like gold, but turn out to be pyrite. If that’s true in your case, that doesn’t mean you shouldn’t explore the viability of some of the old tried and true asset protection strategies.