Can A Discretionary Trust Protect Assets From Creditors?

One concern many people have about leaving assets to heirs and beneficiaries is that creditors may attempt to intercept those assets and use them to pay off debts, leaving the intended inheritor with nothing. There are a few ways you can prevent this from happening, and one option is to set up a discretionary trust. Here's more information about this type of trust and how it may help protect your loved ones from creditor machinations.

About Discretionary Trusts

A discretionary trust is one where the assets in the trust are distributed to the beneficiaries at the discretion of the trustees. No one beneficiary has ownership of the trust or anything in it; rather, the trust is "owned" by the trustee who then decides who (from a list of beneficiaries) will receive the proceeds from it and the amount.

For example, a mother leaves a home and $100,000 in a discretionary trust for her children and names her brother as the trustee. Instead of distributing a fixed amount of money to the kids on set dates (e.g. $1,000 per month), the uncle gives the children money whenever he decides they need it in the amounts he chooses (e.g. $5,000 one month, $2,000 another).

Because the beneficiaries don't actually own anything in the trust, creditors cannot access it. Thus, even if the beneficiary files bankruptcy or a creditor sues the person for payment of a debt, the assets in the trust could not be taken since the beneficiary doesn't legally own it. This is a good way to leave money to a beneficiary who has a lot of financial debt and/or legal problems.

Things to Be Aware Of

Although discretionary trusts can be a useful tool for keeping assets out of creditor reach, there are a couple of drawbacks to this type of trust. The trustee controls who receives proceeds from the trust and when, which leaves the door open to potential abuse, especially since beneficiaries have little legal recourse to force the trustee to disburse payments. It's important to appoint someone who is trustworthy and will treat inheritors with respect or appoint two trustees who can oversee each other's activities.

The fact that the beneficiary doesn't actually own anything in the trust can prevent him or her from using the trust as a source of income to qualify for housing or credit, which can be problematic if the inheritor has limited ability to earn income in other ways (e.g. due to a disability). If this is a concern, you can leave a request with the trustee to disburse monies at regular intervals from the trust to mitigate this issue, but the trustee is not required to follow your directions.

For more information about this or other types of trusts or help with estate planning, contact an attorney, such as at Lynn Jackson Shultz & Lebrun PC.