What Is an Asset Protection Trust and How Does It Work?

An asset protection trust (APT) is a legal instrument designed to insulate a person’s wealth from potential future risks like lawsuits and creditor claims. By transferring assets into a properly structured APT, an individual legally separates from the ownership of those assets, placing them beyond the reach of those who might later seek to claim them. This type of trust is not a tool for evading existing debts or for engaging in illegal activities like tax evasion or concealing assets from government authorities.

Core Concepts of an Asset Protection Trust

An asset protection trust involves three roles: the settlor, the trustee, and the beneficiary. The settlor, also known as the grantor, is the individual who creates the trust and transfers assets into it. The trustee is the person or financial institution responsible for managing the trust’s assets according to the trust document, while the beneficiary is the individual or group entitled to receive benefits.

The settlor is often also named as a beneficiary, allowing them to receive distributions from the assets they once owned. However, the settlor cannot retain too much control without undermining the trust’s protective qualities.

A defining characteristic of an APT is its irrevocability. Once the settlor transfers assets into the trust, they relinquish legal ownership and control, creating a legal barrier between the assets and future creditors.

To fortify its defenses, an APT includes a spendthrift provision. This clause prevents beneficiaries from selling or transferring their interest in the trust and prohibits their creditors from seizing that interest to satisfy a debt. The trustee is given sole discretion over distributions, meaning a beneficiary has no absolute right to demand payments, and therefore a court cannot compel a trustee to make a payment.

Domestic vs. Foreign Asset Protection Trusts

Asset protection trusts fall into two categories based on jurisdiction: domestic and foreign. A Domestic Asset Protection Trust (DAPT) is established under the laws of one of the U.S. states that have enacted authorizing legislation. Around 20 states, including Nevada, South Dakota, and Delaware, have such statutes, which require appointing a trustee who resides or is based in that state.

The appeal of a DAPT is its relative simplicity and lower cost compared to a foreign trust, as it operates within the U.S. legal system. However, a DAPT’s vulnerability lies in the U.S. Constitution’s “Full Faith and Credit Clause.” This clause requires courts in one state to honor the judgments of another, meaning a judge in a non-DAPT state could refuse to recognize the trust’s protections and order assets turned over to a creditor.

In contrast, a Foreign Asset Protection Trust, or offshore trust, is established under the laws of a sovereign nation outside the United States. Jurisdictions such as the Cook Islands, Nevis, and Belize are popular choices because their legal frameworks are designed to create significant obstacles for creditors.

Creditor protection is much higher with a foreign trust because a U.S. court judgment is not automatically enforceable in these jurisdictions. A creditor must hire local legal counsel and re-litigate their case in the foreign court, a process that is expensive and subject to a high burden of proof.

This protection comes at a price, as foreign trusts are more expensive to establish and maintain. Initial setup fees can range from $10,000 to over $30,000, with annual administrative and trustee fees between $3,000 and $10,000. They also involve international law and require filing IRS Forms 3520 and 3520-A.

Tax Consequences of Creating and Funding a Trust

Creating and funding an APT has significant tax implications. Transferring assets into an irrevocable trust is considered a taxable gift, requiring the settlor to file IRS Form 709, the United States Gift Tax Return. An immediate tax liability is often avoided by using the lifetime gift and estate tax exemption, which for 2025 is $13.99 million per individual.

Under current law, this exemption is scheduled to be reduced at the end of 2025, and any exemption used for gifts reduces the amount available to shelter an estate from future taxes.

For income tax purposes, most APTs are structured as “grantor trusts.” This means all income, gains, and deductions generated by the trust are reported on the settlor’s personal income tax return. The settlor is personally responsible for paying the income taxes on the trust’s earnings, even if they receive no distributions.

By paying the trust’s income taxes, the settlor allows the assets within the trust to grow unencumbered by tax obligations, preserving the principal for the beneficiaries.

A properly structured APT can also have favorable estate tax consequences. Because the settlor has irrevocably given up ownership and control, the assets are excluded from their gross estate upon death. For individuals with a net worth exceeding the federal estate tax exemption, this can result in significant tax savings for their heirs.

The Process of Establishing a Trust

Establishing an asset protection trust is a formal legal process that requires professional guidance and involves several steps:

• Engage an experienced attorney. This is a specialized field, and an attorney who focuses on asset protection law is needed to structure the trust effectively, particularly if a foreign jurisdiction is involved.
• Determine jurisdiction and select a trustee. The settlor and their attorney will analyze goals and assets to choose either a U.S. state with favorable DAPT laws or a foreign country, and then select a qualified trustee.
• Draft the trust document. The attorney will draft the legal agreement that formally names the settlor, trustee, and beneficiaries. This document contains the spendthrift clause and outlines the trustee’s discretionary powers.
• Fund the trust. A trust provides no protection until assets are legally transferred into its name. This involves formally retitling assets, such as recording a new deed for real estate or re-registering investment and bank accounts in the name of the trust.