Many people I meet would benefit from an irrevocable asset protection trust, a strategy generally assumed to be too complicated and too expensive. But I am not referring to families with vast inherited wealth or the Mark Zuckerberg-type entrepreneurs. So how do you know if an asset protection trust might be right for you? Consider the value of these assets you may own:
If the combined value of these assets exceeds $500,000, then you are an excellent candidate for an asset protection trust.
So how does the asset protection trust work?
An asset protection trust is created when a person transfers ownership of an asset into an irrevocable trust, which is managed by a trustee for benefit of one or more beneficiaries. The assets you contribute to an irrevocable trust may qualify for protection from your future or unknown creditors. The catch is that you cannot name yourself as both trustee and beneficiary like you would normally in a revocable living trust for probate avoidance. In other words, you cannot establish your own irrevocable asset protection trust and retain the sole discretion to make distributions back to yourself. This arrangement does not provide any asset protection and is against public policy in all 50 states.
Some states like Wyoming and Nevada do permit self-settled asset protection trusts using a third-party trustee in that state, which means residents of those states may remain a beneficiary of the trust and, after any applicable statute of limitations expires, protect the trust assets from their own future or unknown creditors. Although Arizona law does not permit self-settled asset protection trusts (at least not yet; see update below), an Arizona trustor may still obtain the desired creditor protection by establishing the trust in Arizona, excluding the trustor as an eligible beneficiary, and relying on spendthrift or discretionary trust provisions available under Arizona law to protect the trust assets from creditors of the eligible beneficiaries.
But there is good news on the horizon for Arizona residents. In 2020, the Probate and Trust Section of the State Bar of Arizona adopted a proposed statute permitting self-settled asset protection trusts (a/k/a “qualified spendthrift trusts”), which may soon be enacted into law by the Arizona legislature and governor. However, even if enacted, I will continue to recommend establishing the asset protection trust as a third-party discretionary trust. This “hybrid” approach omits naming the trustor as an initial beneficiary (i.e., not self-settled) but permits an independent trust protector to later add the trustor as an eligible beneficiary, subject to the then-applicable qualified spendthrift trust rules.
For Arizona residents, I recommend two options when naming trust beneficiaries:
Option #1- Family Gifting Trust (Trustor’s Children are Lifetime Beneficiaries)
In Option #1 you would name one or more children (or other non-spouse beneficiaries) as eligible beneficiaries during your lifetime, excluding yourself or your spouse. The advantage is that you may serve as trustee and maintain full control of the assets in the irrevocable trust. The trust may be established as an individual trust or a joint trust. Although your beneficiaries would have a right to information about trust assets, you retain discretion whether to make any distributions to them during your lifetime. The trust assets are protected from your future or unknown creditors - because you are ineligible to receive distributions - and from creditors of the beneficiaries (using spendthrift or discretionary trust provisions available under Arizona law).
Option #2- Spousal Lifetime Access Trust (Trustor’s Spouse is a Lifetime Beneficiary)
In Option #2 you would include your spouse as an eligible beneficiary during your lifetime, and if desired, name your spouse as trustee. Similar to Option #1 the trust assets will be protected from your creditors during your lifetime - because you are ineligible to receive distributions - and from creditors of your spouse and beneficiaries. The difference here is that your spouse is an eligible beneficiary, allowing your spouse to receive distributions from the trust if there is a legitimate need. The trust must be established as an individual trust with any contributions coming from your separate property or your one-half of community property after partition.
Both approaches may be referred to as hybrid asset protection trusts because either may be drafted to include a provision giving an independent person or company called a trust protector the power to move the trust to another state or country that permits self-settled asset protection trusts (or simply wait until Arizona permits them). This change of governing law might permit the trust protector to add you as an eligible beneficiary later.
 There are exceptions to this general rule. For example, Arizona law does not shield the trust assets from child support claims. Also, the strategy is not likely to work if you transfer all your personal assets to the trust. You must remain solvent on your personal net worth statement, even after contributing assets to the irrevocable trust.
 19 states permit self-settled asset protection trusts in some variation. The most well-known are Alaska, Nevada, Wyoming, and South Dakota. Unfortunately, the full faith and credit clause of the U.S. Constitution makes it unlikely an Arizona court would respect the governing law of a self-settled asset protection trust established in one of these states for an Arizona resident. Foreign asset protection trusts avoid this problem in theory, but if the full protection of the trust is triggered by an actual threat, case law has shown the beneficiary also loses access to the trust assets unless willing to move permanently outside of the United States. This is an unintended consequence most people are not willing to accept.
Thomas J. Bouman