Does a Trust Protect Your Assets from a Lawsuit?

The short answer

A trust may protect your assets from a lawsuit, but a revocable living trust may not. Whether a trust can help depends on three things: what kind of trust it is, who created it, and when it was funded.

Does a revocable living trust protect your assets?

Many people believe their living trust keeps their savings safe from a lawsuit. This may not be true.

A revocable living trust is a useful estate planning tool. It can help your family avoid probate and keep your affairs private. But it was never designed to protect you from creditors.

The reason is control. You can change or cancel a revocable trust at any time and take the assets back. Because you keep that control, the law treats the assets as your assets.

Florida's statute says so plainly: "The property of a revocable trust is subject to the claims of the settlor's creditors during the settlor's lifetime" (Fla. Stat. 736.0505(1)(a)). The "settlor" is the person who created the trust.

In other words, if someone wins a judgment against you, assets in your living trust may be reached as if the trust didn't exist. State rules differ in their details, so check how your state treats revocable trusts.

Does an irrevocable trust protect your assets?

An irrevocable trust generally can't be changed or canceled once it's signed. But "irrevocable" alone doesn't decide whether it protects you. What matters is who created the trust and who benefits from it.

A trust someone else created for you. Say a parent leaves you an inheritance in a trust with a spendthrift clause. That clause stops you from transferring your interest, and it stops your creditors from reaching it before it's paid out. Under Florida law, a trust like this can generally keep your interest away from creditors (Fla. Stat. 736.0502). However, once money is distributed to you, it's yours, and creditors may reach it.

A trust you created for yourself. This is called a "self-settled" trust. Florida generally doesn't protect it, even if it's irrevocable. The statute says "a creditor or assignee of the settlor may reach the maximum amount that can be distributed to or for the settlor's benefit" (Fla. Stat. 736.0505(1)(b)).

In plain terms: if the trustee could pay it to you, your creditor may be able to take it.

There are many kinds of irrevocable trusts, each built for a different purpose. Click here to view our guide to the different types of irrevocable trusts.

Trusts built to protect you: domestic and offshore

Some trusts are designed for asset protection even when you are a beneficiary. They fall into two groups.

Domestic asset protection trusts (DAPTs). The states that have passed laws that allow a self-settled asset protection trust vary. Florida is not one of them. Our DAPT facts page lists the states that allow them and the court cases where they failed.

Bankruptcy is a known weak point for these trusts. Under federal law, a bankruptcy trustee can void a transfer to a self-settled trust made within 10 years before the filing, if it was made with actual intent to hinder, delay or defraud creditors (11 U.S.C. 548(e)).

Offshore asset protection trusts. Other people turn to a trust governed by the laws of another jurisdiction, such as the Cook Islands. As a general guide, offshore planning may be worth considering when you have about $500,000 or more to protect.

To learn how these trusts work, see our articles on the asset protection trust, the Cook Islands Trust, and the Cook Islands Trust vs. DAPT.

Wondering how much access you would keep? Click here to read how often you can pull assets out of your trust.

Timing: when a trust stops working

Even a well-designed trust may fail if it's funded at the wrong time or for the wrong reason.

The law lets a court undo a voidable transfer (often called fraudulent-transfer law). In Florida, a transfer made with actual intent to hinder, delay or defraud a creditor can be voided whether the creditor's claim arose "before or after the transfer was made" (Fla. Stat. 726.105).

That means you don't have to be sued yet for a transfer to be challenged. If you moved assets because you saw trouble coming, a court may look closely at why.

There is a deadline. In Florida, a creditor generally must bring this kind of claim within 4 years after the transfer, or within 1 year after the transfer was or could reasonably have been discovered, if that is later (Fla. Stat. 726.110). Other states may set their own deadlines.

The practical lesson: a trust can be the most beneficial when it's set up while things are calm, before any claim is on the horizon. For more information, see the four rules of offshore trusts and asset protection before vs. after a lawsuit.