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Asset Protection Trusts: effective or not? P.1

A recent Forbes article took a look at the general effectiveness of asset protection trusts in light of a recent Alaska case in which a man who set up and funded an asset protection trust was unable to protect his assets from future creditors in bankruptcy.

There are four different general categories in which asset protection trusts are considered. Whether or not the asset protection trust is effective will depend on whether bankruptcy is involved and whether the debtor is residing in a state with asset protection trust recognition.

Some states do not protect interests in self-settled trusts from creditors' claims. In those states, the debtor's interest in a self-settled trust will be part of the bankruptcy estate, if bankruptcy is part of the picture. In these situations, a bankruptcy court will use the law of the state in which it resides, which usually results in application of the spendthrift trust laws of that state.

If no bankruptcy is involved but the debtor is not residing in a state that protects interests in self-settled trusts from creditors' claims, the usual conflict-of-laws tests used by courts allow them to apply local law allowing creditors to invade the debtor's trust assets.

The picture looks a bit better when the debtor is a resident in a state with recognition of asset protection trusts. What isn't less certain is whether the assets will be protected in the event of bankruptcy. If the debtor resides in a state with asset protection trust recognition and bankruptcy is not involved, local courts will likely respect the trust in all but the most egregious of situations.

If bankruptcy is involved, the trust should be protected as long as it has been set up 10 years prior to the bankruptcy. The law governing that limitation period was adopted in 2005, and it is still developing, according to sources.

In our next post, we'll continue looking at this story and a bit more about asset protection trusts.

Source: Forbes, "Easy Chart Regarding Effectiveness of Asset Protection Trusts," Jay Adkisson, November 15, 2011.

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