Although President Biden has suggested that he wants to roll back current federal gift and estate tax exemption amounts (reducing the estate tax exemption to $3.5 million, imposing a top estate tax rate of 45%, and reducing the gift tax exemption to $1 million), any proposals would have to be passed in Congress. In the meantime, one benefit of the current federal gift and estate tax exemption of $11.7 million in 2021 is that when it comes to estate planning, most people are free to focus on asset protection and wealth preservation, rather than tax minimization.
If you’re more concerned about personal liability at the moment, an asset protection trust is worth considering, as it can shield hard-earned wealth against claims and lawsuits from frivolous creditors. Although foreign asset protection trusts offer the best protection, they can be complex and expensive, and it may be worth considering a domestic asset protection trust (DAPT) as another option.
Standard and hybrid DAPTs
Standard DAPTs come with both benefits and potential risks. On one hand, a standard DAPT offers you creditor protection even if you’re one of the trust’s beneficiaries. On the other hand, DAPTs haven’t been the subject of a great deal of litigation, which means there’s some uncertainty over their ability to repel creditors’ claims. Although many experts believe they’ll hold up in court, there’s still some risk involved.
“Hybrid” DAPTs offer the best of both worlds. Since you aren’t initially named as a beneficiary of the trust, the risk described above is virtually eliminated. However, the trustee or trust protector can add you as a beneficiary if you need access to the funds in the future, converting the trust into a DAPT.
It’s worth determining whether you even need such a trust before you consider a hybrid DAPT. Transferring assets to your spouse, children, or other family members—either outright or in a trust— without retaining any control will place assets beyond the grasp of creditors and is generally the most effective asset protection strategy. In this case, your creditors won’t be able to reach the assets so long as the transfer isn’t designed to defraud known creditors. In addition, you’ll still have indirect access to the assets through your spouse or children even though you’ve given up control, as long as your relationship with them remains strong.
A standard DAPT may be a better option, however, if you want to retain access to the assets without relying on your spouse or children.
Establishing a hybrid DAPT
Initially, hybrid DAPTs are created as third-party trusts, meaning that they benefit your spouse, children, or other family members, but not you. The trust isn’t a self-settled trust since you aren’t named as a beneficiary, and it thus avoids the uncertainty associated with standard DAPTs.
A properly structured third-party trust will certainly allow you to avoid creditors’ claims—and the trustee or trust protector has the authority to add additional beneficiaries, including you, in the event that you need access to the trust assets in the future. If that happens, however, the hybrid account is converted into a regular DAPT and is vulnerable to the same risks discussed previously.
Contact us today if you have additional questions regarding DAPTs, hybrid DAPTs, or other asset protection strategies.