As American society is becoming more litigious, there is the increasing threat that you might end up on the wrong side of a lawsuit even if you did not intend any wrongdoing. Car accidents, health bills that exceed the coverage of your health insurance, bad business deals, and professional malpractice can all present threats to your hard-earned assets. Estate planning can provide many opportunities for asset protection planning.
Traditionally, the law has not allowed asset protection for persons who establish trusts for their own benefit with their own assets. Some states, such as Nevada, Delaware, and Alaska, created statutory exceptions to this general rule that allow people to utilize special types of trusts to create asset protection for their own assets. These are known as “Domestic Asset Protection Trusts” or “DAPT’s.” California Probate Code Section 15404, however, specifically states that it is against the state’s public policy to recognize DAPT’s.
Although it is not possible under California law to establish an asset protection trust for one’s own benefit with one’s own assets, there are several California laws that allow the creation asset protection trusts for the benefit of third parties such as children or other loved ones. Such third-party asset protection trusts can be incorporated into a living trust by providing a beneficiary with an “in-trust inheritance” as opposed to the more common and traditional “outright distribution.”
The three most common types of third-party asset protection trusts allowed under California law are spendthrift trusts, support trusts, and discretionary trusts.
California Probate Code Sections 15300 and 15301 state that a California trust can provide that a beneficiary’s interest in the income and principal of a trust cannot “be subject to voluntary or involuntary transfer.” The idea behind this provision is that a beneficiary cannot assign his/her interest in a trust to a third party, including a creditor.
A key limitation to this type of trust is that once income or principal is actually distributed to the beneficiary, the asset protection is lost. Furthermore, there are statutory exceptions to the asset protection provided by spendthrift trusts. For example, a spendthrift trust will not protect a beneficiary against claims of child support of spousal support. Furthermore, other types of creditors might be able to reach up to 25% of the income or principal of the trust under certain situations.
California Probate Code Section 15302 provides that a trust that specifically provides for a beneficiary’s education and support cannot be reached by the beneficiary’s creditors, at least until assets of the trust are actually distributed to the beneficiary. “Support” can include support for the beneficiary as well as the beneficiary’s spouse and minor children.
California Probate Code Section 15303 specifically authorizes discretionary trusts. A discretionary trust gives complete discretion to the trustee to decide whether or not to distribute any income or principal to the beneficiary: the trustee may give all of the trust assets to the beneficiary; none of the assets of the trust to the beneficiary; or any amount in between.
Because the beneficiary cannot enforce a trust distribution, a beneficiary’s creditor also cannot enforce a trust distribution. As such, a discretionary trust is the most effective asset protection trust allowed under California law.
Other Asset Protection Strategies
Although California limits asset protection trusts to the benefit of third parties, California does allow for other asset protection strategies for that can protect a person’s own assets. These include Limited Liability Companies (“LLC’s”), corporations, professional corporations, liability insurance, and retirement plans such as IRA’s and private retirement plan trusts.
Although other states such as Nevada, Delaware, and Alaska, have better reputations than California for asset protection, there are still many opportunities for asset protection strategies that are directly recognized under California law. Engaging in estate planning presents a good opportunity to explore the possibility of maximizing the full potential of trusts and other legal instruments that can provide a significant degree of asset protection in a variety of circumstances.
KRASA LAW, Inc. is located at 704-D Forest Avenue, Pacific Grove, California 93950 and Kyle may be reached at 831-920-0205.
Disclaimer: This article is for general information only. Reading this article does not establish an attorney-client relationship. Before acting upon any of the information presented in this article, you should consult a competent attorney who is licensed to practice law in your community.