What is a protective trust?

The term "protective trust” is something of an umbrella term in the U.S., covering various types of trusts that are put in place to protect a person's estate and/or assets from taxation, bankruptcy, lawsuits, a rogue beneficiary or other threats. In general, a protective trust is designed to make sure the income from the trust goes to the beneficiary for whom it was designated, and that this transfer will not be altered or interfered with in any way.

How Does a Protective Trust Work? 

In the United States, a protective trust is often referred to as an "asset-protection trust," while in the UK and some Commonwealth countries, it's referred to simply as a "protective trust." Both function in more or less the same way and are often created for similar purposes. The manner in which a protective trust works in the United States can vary based on how and why the protective trust was set up. A protective trust can contain an agreement that must be signed by the beneficiary. This agreement generally states that he or she loses rights to the income should certain conditions not be met.

A protective trust is often set up for the purpose of paying out an annuity, or annual income of a pre-determined amount. It may also be set up to pay out only for a specific purpose (such as an education trust or a trust to care for a special needs child). This may be done to ensure the beneficiary doesn't spend the full assets in the trust (this is often called a spendthrift trust). The beneficiary may be an heir specified by the donor, or may be the donor himself. Many people, for example, might use a protective trust in order to ensure an income even after retirement and to protect those assets from collection from creditors. 

Why Use a Protective Trust?

In ordinary situations, any income that a beneficiary receives from a trust is considered an asset of the beneficiary. This means that income is subject to being intercepted and/or changed in ways the donor may not agree with. The beneficiary, for example, could sell the right to the income or he or she could also lose it should bankruptcy be filed or should a lawsuit be brought in court.

When a trust owns the assets, that trust is a separate legal entity from the creator or beneficiary. This separation provides great protection. For example, if the beneficiary is sued (whether that beneficiary is the person who set up the trust or not), any assets in the protective trust may be more difficult or even impossible to access in the event of a lawsuit depending on how that trust was initially set up. 

Getting Legal Help

Setting up a protective trust can be fairly complex, and it's highly recommended that you get the advice of an estate planning lawyer to assist you in deciding what type of protective trust is appropriate for your situation. You must also work with your beneficiary to ensure he or she understands the terms of the protective trust contract clauses in full.