Asset protection is a vital part of estate planning. Indeed, you want to pass on as much of your wealth to family and friends as possible. This can be achieved only if you shield your assets from frivolous creditors’ claims and lawsuits.

One option available is to establish a domestic asset protection trust (DAPT) in the many states that currently offer them. (You don’t necessarily have to live in one of those states.) While DAPTs can offer creditor protection even if you’re a trust beneficiary, there are risks involved: DAPTs are relatively untested, so there’s some uncertainty over their ability to repel creditors’ claims.

A “hybrid DAPT” offers the best of both worlds. Initially, you’re not named as a beneficiary of the trust, which virtually eliminates the risk described above. But if you need access to the funds down the road, the trustee or trust protector can add you as a beneficiary, converting the trust into a DAPT.

A hybrid DAPT in action

A hybrid DAPT is initially set up as a third-party trust — that is, it benefits your spouse and children or other family members, but not you. Because you’re not named as a beneficiary, the trust isn’t considered a self-settled trust, so it avoids the uncertainty associated with regular DAPTs.

There’s little doubt that a properly structured third-party trust avoids creditors’ claims. If, however, you need access to the trust assets in the future, the trustee or trust protector has the authority to add additional beneficiaries, including you. If that happens, the hybrid account is converted into a regular DAPT subject to the previously discussed risks.

An alternative to a hybrid DAPT

Before considering a hybrid DAPT, determine whether you need such a trust at all. The most effective asset protection strategy is to place assets beyond the grasp of creditors by transferring them to your spouse, children or other family members, either outright or in trust, without retaining any control.

If the transfer isn’t designed to defraud known creditors, your creditors won’t be able to reach the assets. And even though you’ve given up control, you’ll have indirect access to the assets through your spouse or children (provided your relationship with them remains strong).

A flexible tool

The hybrid DAPT can add flexibility while offering significant asset protection. It also minimizes the risks associated with DAPTs, while retaining the ability to convert to one should the need arise. We can help you assess whether a hybrid DAPT is right for you.

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