Can estate planning shield assets from a beneficiary's creditors?

On behalf of Scaringi Law posted in Estate Planning on Friday, August 7, 2015.

One of the functions of a probate proceeding is to alert potential creditors, so bypassing this entire process can save a lot of time. To that end, readers may associate trusts as an estate-planning tool for avoiding probate. Certainly, the time and expense saved by a direct transfer of assets to beneficiaries is a great advantage of trusts.

Trusts can also serve other functions; sometimes helping to preserve and pass on the testator’s values to his or her loved ones. In other cases, a trust might contain restrictions to protect the beneficiary's inheritance from creditors. In regard to protecting estate assets from creditors, a recent article reminds us of several strategies for maximizing the extent to which one’s estate can be made creditor-proof.

The starting point, not surprisingly, is utilizing trusts, payable-on-death accounts, and other non-probate assets to avoid probate in the first place. The general rule is that creditors can only go after assets that are in the debtor’s control and/or possession. To the extent that the principal in a trust is controlled by a trustee and not accessible by a beneficiary, it should also be protected from any claims brought by the beneficiary’s creditors.

What about retirement accounts? The answer partly depends on the type of transfer. Spousal rollovers include IRA assets, and those funds are typically protected from outside creditors. However, that may not be true for a non-spousal beneficiary. For example, if a child inherited a parent’s 401(k) account and then became liable for a damages award or other expense, a creditor could potentially move against the funds in the IRA. One solution might be a stand-alone IRA trust for loved ones.

Source: AARP, “Make Your Estate Creditor-Proof,” Lynnette Khalfani-Cox, July 30, 2015