When are trusts protected from creditors?
A trust can allow assets to be transferred soon after your loved one's passing, without needing to go through a legal probate process.
The type of trust your loved one held will determine if creditors can make a claim against that trust.
Irrevocable living trusts are almost always completely protected from creditors, as they were entirely out of your loved one's ownership and control.
Other types of trusts that do not go through probate, such as revocable trusts or charitable trusts, can still be claimed by creditors, at the court's discretion.
It’s a fairly common practice for people to place a large portion of their assets into trusts for their beneficiaries to inherit after their death. If your loved one did so, there are some details that are important to understand. While this is probably the last thing you want to be thinking about while you’re mourning your recent loss, knowing more about trusts will help you down the line.
Having a trust is good for a number of reasons: It transfers the ownership of assets quickly, it can keep the assets out of probate, and it ensures that they get distributed how the person desires. In some cases, it can also protect the assets in the trust from liability for the debts of the estate.
However, this is only true of very particular kinds of trusts, and even then, the trust may be subject to claims by creditors. This is based on details like how the trust was set up and the time frame that creditors have to make claims.
The paperwork and responsibility of trying to figure out who has the right to what assets is hard work at an already tough time—but with the right info, it doesn’t need to be overwhelming.
Types of trusts
The type of trust your loved one left is the biggest factor in whether or not it could be liable for the debts of the estate. Though there are others, these are the some of the most common kinds of trusts you might encounter.
A revocable trust is created during the person’s lifetime and can be modified or revoked at any time while they are alive. The creator, or grantor, of this kind of trust transfers the title of the property placed in the trust to the trust itself, but retains control of the trust in that they are able to change its terms or end it. The grantor may appoint a trustee to manage the trust, or may act as the initial trustee themselves and name a successor trustee for after they pass away. The trustee is in charge of maintaining the trust on behalf of its beneficiaries according to the trust's instructions.
Typically, any asset that is owned by the trust at the time of your loved one’s death will not be subject to probate, as they were not technically in their possession but the trust's. However, as the trust was still under their control, it is not protected from creditors.
Contrary to popular belief, there are some cases where a trust can be subject to the claims of creditors.
If the probate estate does not have enough assets to cover its debts, the creditors will petition the court and can then gain access to the funds in the trust.
A revocable trust becomes irrevocable upon the original creator's passing. But this is not relevant to whether creditors can access it, as the trust was not irrevocable during the person's lifetime, and it does not receive the protections that irrevocable trusts are entitled to.
Unlike a revocable trust, an irrevocable living trust can not be changed or ended after its creation. Generally speaking, no one, including the grantor and their creditors, can take assets out of the trust, as long as it was not funded in order to defraud creditors. Once your loved one has passed away, the property in the trust will be maintained or distributed as instructed, free from any creditor claims as well as from the probate process.
This is usually done by creating separate lifetime trusts for each of the beneficiaries, which grants them access to the assets at any time, for any need they see fit.
There is a special kind of irrevocable trust called a self-settled trust, in which the person names themselves as a beneficiary. In this case, while the trust is not part of the probated estate, it is not always protected from creditors.
Trusts that are created by the will itself, known as testamentary trusts, are subject to probate. Their assets remain part of the estate and can be used to pay estate debts.
As the name denotes, these are trusts in which the property is left to charity. These trusts can potentially lower the estate tax for any other assets going through probate. Such trusts can be set up in a variety of ways, some of which are vulnerable to creditors, while others are protected.
When and how creditors can make claims
In order to give creditors a chance to collect on a debt, the executor of your loved one's estate needs to publish a notice of the death in the local paper and send notification to any known creditors. Creditors then have a window to make claims for unpaid debts; this period varies by state, but it typically falls between four and six months.
If you’re the trustee, it’s a good idea to wait for this period to pass before making distributions from potentially liable trusts to any beneficiaries. If creditors you weren’t expecting come calling, trying to collect money or property back from family can be an incredibly tense process. And if you aren’t able to, then you could be held personally liable to the creditor for those payments, which is truly the last thing you want to deal with right now.
Trusts and the legal system around creditors are not the easiest things to understand, especially when you don’t have much mental energy to devote to it. When you’re grieving, all these financial responsibilities and questions can feel numbingly mundane and inconsequential.
Remember, if your loved one left behind a trust—whether it benefits you, your family, or a charity they believed in—they did it because they wanted to ensure that their assets (and their beneficiaries) were handled with care. It was one of the ways they attempted to look out for you and your family after they were gone, and fulfilling it is a way of honoring their wishes and their memory ●
Tax benefits of trusts
If your loved one left all or some of their assets in trusts, they may have had many reasons for doing so, primarily avoiding probate. There are also several potential tax benefits, however, that you should be aware of.7 min read
Can I avoid probate?
Not every estate needs to go through the full probate process. Whether full probate is needed depends on the size of the estate, how it was held, and the laws of the state in which your loved one lived or held property.5 min read
Prioritizing debts for insolvent estates
Settling your loved one’s debts is a key part of dealing with their estate. Although you most likely won’t be paying your loved one's debt out of your own pocket, you will need to understand the different types of debt owed and how to prioritize them.5 min read