An asset protection trust is a type of irrevocable trust that provides protection for one's assets from creditors, lawsuits, avoid probate taxes, yet still reserves certain benefits or control of the settlor over the assets. These trusts are rather common in estate and tax planning, offering protection against possible lawsuits or claims of creditors. DAPTs represent some of the most effective legal means of asset protection and preservation of an estate, which substantially benefits individuals concerned with the protection of family wealth.
Let's take a deeper dive into how DAPTs work, their pros and cons, and if this type of trust is right for your financial plan.
What is a Domestic Asset Protection Trust?
A DAPT is a legal arrangement whereby some person—the "grantor"—puts his assets into a trust and, by doing so, protects those assets from creditors. What distinguishes the DAPT from other kinds of trusts is the ability it extends to the grantor to continue to benefit in some ways from the assets even though he no longer technically owns them.
While the assets are contributed to the trust and managed by a trustee, the grantor might still receive distributions or income from those assets. It is just this kind of duality in nature that makes DAPTs specifically appealing to those seeking protection of their wealth against future claims, yet still retaining some degree of financial access.
Not all states in the U.S. permit DAPTs. To date, only a handful of states have enacted legislation to permit such trusts; these include Alaska, Delaware, Nevada, and South Dakota. Each of these states has its own requirements as to the nuts and bolts of establishing and maintaining a DAPT, and the actual degree of asset protection available underneath a given DAPT may change with the jurisdiction wherein that DAPT was established.
Key Features of a DAPT
Irrevocability: One of the salient features of a DAPT is its irrevocability, in that once a DAPT has been set up, it cannot as easily be amended or recanted. Because of this very permanency, DAPT offers those tremendous powers of asset protection. Through the divesting of the grantor of control over such assets, the trust protects those assets against creditors since they can no longer be reached by them. Also, access to the funds is difficult for the individual except as outlined in the terms of the trust.
The grantor as beneficiary: Unlike most other types of irrevocable trusts, the grantor can be added as one of the beneficiaries under a DAPT. In this respect, while assets are no longer held directly by the grantor, he or she may be entitled to benefit financially from the income or distributions of the trust.
Asset protection is the designed model for DAPTs. Once assets are transferred into a DAPT, they legally become the property of the trust. So long as the transfer of the assets into the trust pre-dates the creditor claims against the assets, creditors generally cannot access or make claims against the assets held in a trust.
State-Specific Legislation: The laws of DAPTs are state-specific; not all states offer the same amount of protection. That, in turn, means that the efficiency of a DAPT will largely depend on specific state law where the trust is created. Certain states, including Nevada and South Dakota, have developed a reputation for offering the most powerful protections.
How Does a DAPT Work?
Generally speaking, a grantor creates a DAPT and transfers the ownership of certain assets to that trust. The trustee manages assets and is responsible both for their use and for distributing them in accordance with the terms of the trust. In other words, legally, the grantor is no longer considered the owner of the assets or in outright control of the assets; again, this is key and crucial to the protection of the assets from creditors.
The trustee can be a person or professional entity, such as a bank or trust company, that is responsible for the management of the trust. The trustee determines at what point and how much from the income or assets is passed on to the beneficiaries, including the grantor if he is a beneficiary. This separation of control from the grantor and the assets creates the legal basis for asset protection. So long as the assets no longer belong to him, they cannot be attached by his creditors seeking satisfaction of debts.
However, DAPTs are by no means bulletproof. Where a creditor can establish that the assets were transferred into the trust with an intent to defraud them, courts may rule such a transfer fraudulent and hence permit the creditor access to the assets. Moreover, DAPTs apply only to those assets that were transferred into the trust prior to any claims or liabilities arising.
The Pros and Cons of DAPTs
Pros of a DAPT:
Asset protection in a big way: A DAPT is mainly created to protect substantial assets. Once the assets have been transferred into this trust, they normally remain effectively sheltered from creditors, lawsuits, or other claims.
It is possible for the grantor to still benefit from the assets: Even though assets are placed into a trust, the grantor can still receive considerable financial benefit from those very assets. From that perspective, DAPTs are an attractive option insofar as individuals who do not want to fully give up access to their wealth in their search for protection have an alternative.
Tax Planning Benefits: The nature and use determine that DAPTs have a number of salient features concerning tax planning. They can be quite useful in estate planning, considering the fact that they are employed as one of the means to reduce the value of the taxable estate. By doing so, placing assets into this trust will reduce the value of the grantor's estate, possibly resulting in reduced estate taxes at one's death.
Keeps it Private: In many states, there is no public record for a DAPT. Hence, nobody could know about the trust. This adds an element of privacy for those people that do not want money information in the public domain.
Disadvantages of a DAPT:
Limited Availability: Most states are still behind the power curve, offering only a few DAPT-friendly laws. Availability is limited. If you happen not to be one of those lucky states, you may have to create your trust in yet another state. This could add some real complexity into an already somewhat complex process.
Possible Legal Issues: Creditors can contest the validity of a DAPT; especially if assets were transferred in the trust at such a time when the grantor was facing some existing financial difficulties. The court can set aside the protection accorded to the trust if it is established that there was fraud in the transfer.
Complexity and Costs: Establishment and maintenance require expertise in special law. Unfortunately, a lot of complexity comes fairly expensively, given the charges not just for its establishment but also for ongoing management by a professional trustee.
No Strategy is Full-Proof: While DAPTs provide significant protection, no asset protection plan is full-proof. Outside of state law and particular facts and circumstances, it is conceivable that other avenues may be found by which the creditors could challenge the trust in order to penetrate and gain access to the assets.
How to Establish a DAPT
It takes a few steps to implement a DAPT. There are also many legal formalities that must be observed, which will allow the trust to grant the asset protection sought.
Select Trust-Friendly State: Not all states provide an opportunity to create DAPTs. If the state where you reside does not provide DAPTs, then one would have to incorporate the trust in a state that provides DAPTs. Among the states that currently offer DAPTs are Alaska, Nevada, Delaware, and South Dakota. Because each of these states offers various laws related to the establishment of such trusts, you will want to know what the statutes are in the state where you desire to establish the trust.
Naming of Trustee: You will also need to name a trustee who will manage and administer the assets held in the trust. It can be an individual—a family member or friend—or a professional trustee—a bank or trust company—situated within the state where the DAPT is created.
Funding the trust: After you have drafted your trust, you will be needed to fund your trust with your properties or assets. The property that may constitute this trust includes, but is not limited to, cash, real estate, stocks, and any other valuable property.
Observe Applicable State Laws: Most of the states have specific requirements concerning a DAPT about how it must be created and maintained. You need to follow those laws so that your trust will be valid and be fully effective in protecting your assets.
Statutory Waiting Period: Practically all states have a statutory waiting period that must expire, which is between two and four years; during such time the assets held in the trust are not protected from the creditors of the settlor. Once that has expired, assets are generally safe from future claims.
DAPT vs. Offshore Trusts
For the most protection of their assets possible, the alternative to DAPTs is an offshore trust. Since offshore trusts are created in foreign jurisdictions, it becomes much harder for U.S. creditors to reach them. Generally speaking, offshore trusts are more protective in comparison to DAPTs because U.S. courts have limited jurisdiction over foreign trusts.
These, however, bring with them a host of challenges. They tend to be much more expensive to set up and maintain than local trusts can be and may invite added scrutiny by regulatory authorities. Added to which, the management of assets in foreign jurisdictions may be complex, requiring more extended legal expertise.
While both DAPTs and offshore trusts provide excellent asset protection, the general ease of establishment and maintenance for those people desiring to keep their assets onshore in the U.S. make DAPTs generally preferable.
Who Should Consider a DAPT?
DAPTs are ideal for those individuals who wish to have protection against creditors at some point in the future but still need access to those assets. They are popular among doctors, business owners, and real estate investors alike, usually being sued or otherwise pursued through courts on an almost routine basis.
However, DAPTs are not for everybody. If you happen to be pursued by your creditors at this time or involved in some litigation, transferring your assets into such a trust will not protect you. This is because the court can find out that such a transfer was fraudulent so it will render this kind of trust useless.
Conclusion: Is a DAPT Right for You?
Accordingly, a Domestic Asset Protection Trust is an extremely strong financial tool for those desiring to block certain assets from the claims of creditors in the future but who still want to benefit from their wealth. It requires great planning to establish a DAPT and involves lots of knowledge in regulating laws, which vary from state to state.
Here, you may need a DAPT if you want protection of assets, estate tax reduction, and retention of some control level over one's financial future. You will, however, still wish to consult with an experienced estate planning attorney to help set up the trust correctly and achieve expected protection.
Ultimately, a DAPT can be a piece of your mind, where your assets will be sheltered from creditors who may someday come knocking, and normally a great choice for you to protect your financial legacy while benefiting from that wealth.
