They play a relatively minor role. There are hundreds of different trusts, and each has its specific purpose for estate or financial planning. But for creditor protection, the trust must be irrevocable and intervivos – or funded during your lifetime. Until you transfer your assets to the trust, your assets, of course, are subject to the claims of your personal creditors.
There are other limitations to the use of trusts to shield one's assets. The trust cannot ordinarily be settled for the sole benefit of the grantor. A grantor seeking lawsuit protection can retain no beneficial interest – though some retention of income rights based on some ascertainable standard (health needs, etc.) may still allow the trust to provide protection. Most states disallow self-settled trusts for Asset Protection. The grantor cannot control the trust nor have any beneficial rights.
Moreover, assets transferred to an irrevocable trust may be subject to fraudulent transfer claims by the grantor's creditors. Present creditors –known or unknown – can recover fraudulent transfers. That's why you must transfer assets to a domestic irrevocable trust only when you're certain you have no present creditors. But how can you ever know this beforehand? For these reasons, unless the trust provides other estate planning benefits, we wouldn't normally use a domestic irrevocable intervivos trust solely to protect a client's assets. The LP or LLC is preferable. However, revocable trusts can shield your children's inheritance and protect your estate. And special purpose trusts, such as irrevocable life insurance trusts, might own your life insurance. For these reasons we generally don't use irrevocable trusts to protect our clients' assets from their creditors but do recommend trusts to protect significant trust assets from their beneficiaries' lawsuits and creditors. These beneficiaries are usually the grantor's children or grandchildren.
This doesn't diminish the role of domestic trusts in our planning. We do use scores of different trusts and each has its application – whether for estate, or philanthropic purposes. And some of these trusts do provide protection. But when we use these trusts it is ordinarily for some purpose other than the protection of the settlor's assets. Protection becomes a secondary or incidental benefit.
When you do think about trusts for protection, you must consider them from several perspectives: 1) Which trusts can protect the assets from the grantor's creditors? 2) Which trusts can protect the assets from the beneficiaries' creditors? 3) How can you improve the protection afforded by a particular trust? 4) What protection can you expect from the more commonly used trust? We will, of course, talk more about trusts, particularly when we talk about how to protect your estate and inheritance.