Asset Protection Trusts. Can They Help You Avoid Estate Taxes in Rhode Island?

Trusts aren’t just for the super-wealthy. They’re a common estate planning tool with many potential benefits, like avoiding probate.

One type of trust, called a domestic asset protection trust, can even shield your assets from creditors and lawsuits and help minimize estate taxes. Rhode Island is one of 20 domestic asset protection states. This allows RI residents to take advantage of this trust’s unique benefits.

If you’re curious to learn more, discover an explanation of domestic asset protection trusts, along with their possible pros and cons, courtesy of a Rhode Island estate planning attorney.

What is a trust?

A trust is a legal relationship where one party, the trustor, gives another party, the trustee, the right to hold assets or property on behalf of a third party, the beneficiary.

A trust is its own entity and has its own rights, similar to an individual person or a corporation. You can place several types of assets into a trust, like property, money, and other valuable possessions.

Once your assets are transferred into the trust, they are no longer considered your property. Instead, they belong to the trust and are managed by the trustee on your behalf.

What are the different types of trusts?

There are multiple types of trusts, each with their own advantages and disadvantages, but they generally fall into one of two categories:

●     Revocable trusts: Also called a living trust or inter vivos trust. The revocable trust can be changed at any time during the trustor’s lifetime. However, they don’t offer protection from certain taxes, like Rhode Island’s estate tax.

●     Irrevocable trusts: An irrevocable trust can’t be changed during the trustor’s lifetime, except under very narrow circumstances, but they can help avoid estate taxes or even be used to qualify for Medicaid benefits.

Learn more about the differences between revocable and irrevocable trusts on our blog.

What is a asset protection trust?

Normally, the trustor can’t serve as the beneficiary in a trust, but a domestic asset protection trust (DAPT) is an exception to this rule.

A DAPT is a type of irrevocable trust that lets the trustor serve as the beneficiary, allowing them to have access to funds in the trust’s account. As the name suggests, they’re designed specifically to protect assets from creditors, lawsuits, or judgments against the grantor’s estate. As an irrevocable trust, they can also help minimize transfer taxes.

Why use a domestic asset protection trust?

So, who might choose to use a DAPT?

Let’s say that you’re a successful business owner who is worried about losing your personal assets to potential risks, like business-related lawsuits, creditors, or unexpected financial liabilities. You might choose to place some assets into a DAPT for protection.

Thanks to a DAPT’s unique terms, you could also maintain some degree of control and enjoy the benefits of your wealth while safeguarding it. You can also incorporate a DAPT into your estate planning. For example: You could structure the trust to include family members as beneficiaries, allowing them to benefit from your protected assets after your passing.

Domestic asset protection trusts vs living trusts: What’s the difference?

A DAPT is an irrevocable trust, while a living trust is a revocable trust. In other words, you can’t change the terms of a DAPT or remove assets from them as easily as you could with a living trust.

However, Rhode Island doesn’t allow revocable trusts to be used for asset protection purposes. So while a living trust may offer more flexibility, it doesn’t come with the same protections as a DAPT.

Can creditors go after an irrevocable asset protection trust?

Generally, no. DAPTs are meant to offer protection from creditors. Since the assets in a trust don’t technically belong to you, a creditor can’t go after them to pay off a debt.

That said, there are scenarios where creditors could seek funds from a DAPT. For example,  DAPTs need to be established with the intent to protect assets from potential future creditors. It can’t be used to defraud existing ones. For that reason, Rhode Island has a four year statute of limitations for DAPTs allowing potential creditors to pursue assets within that time limit.

Additionally, assets inside a DAPT could be vulnerable to a lawsuit if the suit was filed on or before the date of the asset transfer.

The pros and cons of asset protection trusts

DAPTs can come with a variety of benefits and drawbacks.

Pros

●     Keep the benefits. Unlike other types of trusts, a DAPT allows you to serve as a beneficiary and continue to enjoy certain benefits from your assets.

●     Maintain your privacy. Wills and probate proceedings are public record, but trusts aren’t subject to Warick probate court, allowing you to maintain your privacy.

●     Estate planning integration. DAPTs can be structured into your estate planning strategy, helping you ensure that your wealth continues to provide for your loved ones.

Cons

●     Not reversible. As an irreversible trust, it’s not usually possible to change the terms of a DAPT or remove assets. This can make them a drawback for anyone who would prefer more flexible control over their estate.

●     Waiting period. The four-year statute of limitations requires patience and forces a delay on your asset protection.

●     Complexity. The laws surrounding DAPTs are complex and can be difficult to understand.

Additionally, more specific pros and cons of setting up a DAPT can vary based on your situation. So, it’s best to contact a RI estate planning attorney for more detailed advice.

How to set up an asset protection trust in Rhode Island

If you want to learn more about DAPTs in Rhode Island or are interested in setting one up, you should start by contacting a Rhode Island estate planning attorney, like Brian Nappa.

Attorney Nappa can assess your individual needs and determine if you’d be a good candidate for a DAPT. Then, set up all the details and ensure that you comply with Rhode Island law. He can help you protect your estate and your hard-earned assets

Contact his office today to set up a consultation.