Domestic Asset Protection Trusts

Written by Jim Worthington on November 7, 2018

DAPTs are trusts established under the laws of a state such as Delaware, Nevada, South Dakota, Tennessee, Ohio, or Alaska that allows self-settled spendthrift trusts. Historically, one could not protect one’s own assets from one’s own creditors by transferring them to a trust. Over the past 20 years, however, a number of states have changed their laws to allow this. The preceding list of states is not exhaustive of the ones that have done so.

Most states that allow self-settled spendthrift trusts require the settlor (also called the grantor) of the trust to be solvent at the time he or she transfers assets to the trust. In other words, one has to execute this planning technique while one can pay one’s known and reasonably likely creditors. For example, a doctor could not wait until receiving a demand letter from a malpractice lawyer before taking this step.

The way the trust works is that the settlor picks an independent trustee that the settlor can’t control. A bank or trust company in one of the asset protection jurisdictions is the best choice. The settlor can be a discretionary beneficiary of the trust, but the trustee has to have the power to decline to make distributions to the settlor/beneficiary.

Most clients are uncomfortable giving up that much control over their hard-earned money. A new role has developed to reduce those concerns. A trust protector has the power to remove and replace the trustee. The trust protector can’t be under the settlor’s control but can be someone the settlor trusts to do the right thing, like a professional advisor or a sibling.

The domestic asset protection trust is not foolproof. Some states give certain creditors, like child support recipients and spouses, extra protection. The reason given is public policy. It wouldn’t be a good idea for a state to allow this technique if it could lead to an increase in the welfare rolls.

Anyone interested in setting up a domestic asset protection trust should consult a lawyer with experience in the area and should be prepared to give serious thought to the types of protection needed. This type of irrevocable trust needs to be created with the idea that it will be permanent. If the settlor could change it, a creditor could try and force him or her to do so to allow for distributions to the creditor.