Irrevocable trusts are powerful tools in advanced estate planning. They offer significant advantages for tax planning, multi-generational wealth transfers, and beneficiary protection. However, when it comes to shielding your own assets from lawsuits, the protections are limited, particularly under California law.
Let’s take a closer look at how irrevocable trusts work, and when they can (and cannot) protect assets from legal claims.
Irrevocable Trusts and Beneficiary Protection
If your parents create a revocable living trust and within that trust state that your inheritance will be held in trust after their death, that sub-trust for your benefit may be irrevocable. These types of trusts often include spendthrift provisions, which are specifically designed to protect the trust assets from your creditors.
How does this work?
- The trust can continue to provide for your health, education, support, and maintenance.
- However, if a creditor (such as someone who wins a lawsuit against you) tries to collect from your trust assets, the spendthrift clause allows the trustee to withhold distributions and block access to those funds.
- Importantly, the creditor cannot compel the trustee to make payments, nor can they intercept trust distributions.
In short, this setup can protect a beneficiary’s inheritance from lawsuits, divorce claims, and other creditor actions—but only if the beneficiary didn’t create the trust and doesn’t control the distributions.
What About the Trust Creator (Settlor)?
If you are the person creating the trust (the “settlor”) and you wish to protect your own assets from lawsuits or creditors, the rules are very different, especially in California.
In California:
- You cannot use an irrevocable trust to protect yourself from creditors if you are still receiving benefits from the trust.
- The law is clear: a person cannot shield their own assets from creditors by placing them into a trust while still enjoying income, distributions, or control over those assets.
- This is known as the rule against self-settled spendthrift trusts, and it’s designed to prioritize creditor rights over asset protection for debtors.
In contrast, you can use irrevocable trusts to protect your children or grandchildren from creditors. So while you can’t shield your own assets this way in California, you can help protect the next generation.
What About Other States?
There are states—such as Nevada, South Dakota, and Alaska—that permit the use of Domestic Asset Protection Trusts (DAPTs). These are self-settled irrevocable trusts that can, under specific conditions, protect your assets from creditors even while you benefit from the trust.
However:
- These trusts are highly regulated, and usually require notice to existing creditors.
- There’s typically a waiting period (often 2–4 years) before the asset protection features become effective.
- Not all states recognize DAPTs, and California courts may not honor them, especially if the settlor resides in California.
Key Takeaways
- Irrevocable trusts can protect beneficiaries but not the settlor from lawsuits in California.
- A trust set up by your parents for your benefit, with spendthrift provisions, can shield your inheritance from your creditors.
- A trust you create for yourself, even if irrevocable, will not protect your assets from your own creditors if you retain benefits or control.
- Some states allow self-settled asset protection trusts, but they come with strict requirements and limited applicability for California residents.
- Always consult with an experienced estate planning attorney to explore your options based on your state, your goals, and the nature of your assets.
Need help navigating the complexities of irrevocable trusts and asset protection? Contact our office for a consultation with a qualified California trust attorney.
