Does a Revocable Living Trust Protect Me From Creditors?
No, but it protects your kids and is a recommended way to pass down inheritance in Arizona
on January 31, 2019
Updated on June 17, 2022
In the most basic sense, a revocable living trust is a substitute for a will. You can use one to dictate who or what will receive your property after your death. The “revocable” refers to the option of terminating or altering the trust as your situation or desires change.
But, says Jim Lee, an estate planning attorney at Fennemore Craig in Phoenix, there is a common misconception related to these trusts. “The truth is that it can keep you out of probate court and can simplify administration, but the myth is that it protects you from creditors. It does not do that, but it can help protect your children from their creditors,” he says.
What Makes Arizona Different
Unlike in Arizona, a few state laws allow estate planners to use a special type of irrevocable trust called a domestic asset protection trust. The way a DAPT works is you allocate a portion of your assets to the trust, and you name an independent trustee to manage it—“meaning someone other than the person creating or benefiting from the trust, their spouse or family member,” Lee says. That trust is then available to you on an as-needed basis at the discretion of the trustee, and what remains in trust is protected from creditors.
“It can be difficult for a creditor to pierce that type of trust—especially creditors that are located in the state with the DAPT statute,” Lee adds.
What makes Arizona unique, Lee says, is that “once the person who creates an Arizona trust has passed away, the sub-trusts that are then created for that person’s children, the beneficiaries, can have just as much or more asset protection,” he says.
How the Beneficiaries Benefit
“The statutes that protect these trusts in Arizona are very consumer-favorable, and provide the children tremendous flexibility.”
“Essentially, you can give an inheritance to a child in trust, make the child the decision-making trustee, and allow the child to take the assets out whenever they want, but to the extent that the assets remain in the trust, a creditor of the child cannot get at them.”
Another protection: “Because a trust is essentially a segregated pot of assets, it’s easier to keep that separate and apart from the community property of a married child,” Lee says. “So, if that child ultimately gets a divorce, it’s easier to show it’s separate property” and therefore not part of the other spouse’s assets.
There is no limit as to how much these trusts can contain.
The Potential Risks
“This is an untested statute,” Lee says. “It has been on the books in Arizona for years, but it is not something we’ve seen a creditor attempt to strongly attack. So there is some uncertainty.”
If you want to be on the safe side, Lee adds, he would advise that the trust allow a beneficiary child to draw from the trust only for health, education, support in reasonable comfort, and maintenance—and to not draw more than the child needs.
“The terms [support, reasonable comfort, maintenance] are somewhat ambiguous; we have guidance from the treasury regulations as to their meaning, but that guidance is only meaningful in the realm of tax planning. Nevertheless, it is generally understood that this standard is broadly interpreted.”
How Much Time & Money It Costs
As for setting up these types of trusts, Lee says it typically doesn’t involve more than a couple of meetings with a reputable estate planning attorney, who will ask you questions and make recommendations based on your circumstances.
“These trusts are very easy to establish and generally considered an affordable component of an estate plan. The asset protection benefit that kicks in upon the death of mom and dad, if the trust is properly structured, is a lot of bang for your buck,” he says.
They’re often billed as a flat price, he adds, and “it’s not unusual to find someone willing to do them for around $2,500. Of course, you may want to add more bells and whistles, and that could make it more expensive.”
These trusts are not entirely risk-free, but using a revocable living trust is one risk you might find worth taking. “Debtor-creditor courts and family law courts are courts of equity, so judges have broad remedial powers. What that means is the judges are trying to determine what is equitable or fair for the parties under the circumstances, and protections of a statute aren’t always entirely certain,” Lee says. “Nevertheless, having a statute on your side goes a long way.”