We have recently received a number of requests for an irrevocable trust that protects a client's assets from creditors while the client keeps the benefit of those assets. It is an understandable goal, and some states do allow it. Consumer interest has grown as well, with trusts widely advertised as an alternative to a will. This post walks through the Texas law that governs these trusts and the options the TXdocs library offers.

There is no Swiss Army knife trust

As a board-certified estate planning attorney put it to us, there are many trusts for many purposes, but no single trust does it all. Each is built for a specific goal, and the right choice depends on what the client needs the trust to do.

Clients asking for an asset protection trust often have three goals in mind: avoiding probate, protecting assets from creditors, and keeping access to the assets during life. Under Texas law, a trust can achieve some of these together, but not all three for the same person.

Texas does not recognize self-settled asset protection trusts

As a general rule, a settlor cannot create a trust for the settlor's own benefit, keep access to it, and still keep the settlor's creditors out. Texas codifies that rule in Texas Property Code § 112.035(d): when the settlor is also a beneficiary, a spendthrift provision does not stop the settlor's creditors from reaching the settlor's interest in the trust.

Some other states have enacted statutes allowing a settlor to create a trust for themselves that may be protected from creditors. Those statutes reflect those states' policy choices. Texas has not adopted that approach, and a self-settled protective trust runs against Texas public policy.

Where a domestic asset protection trust is the desired goal for a Texas client, that planning is done under one of those states' laws. That generally means a trust sited in that state with a trustee located there. Drafting software that offers these trusts builds them under those states' statutes, not Texas law, which places them outside a library built for Texas practice.

That is also why an irrevocable trust protects assets in the first place. The settlor makes a completed gift and gives up access. Once the settlor can reach the assets, so can the settlor's creditors.

For married clients, a spousal lifetime access trust (SLAT) often comes closest to what these requests are after. One spouse makes a completed gift to an irrevocable trust for the other spouse and their descendants. The beneficiary spouse can serve as trustee and receive distributions for health, education, maintenance, and support (HEMS), so the family keeps indirect access while the assets leave the grantor's taxable estate.

Because the grantor is not a beneficiary, the SLAT does not run into the self-settled trust rule. Any community property used to fund it must first be partitioned into the grantor's separate property, and the beneficiary spouse's interest should end on divorce. If both spouses create SLATs for each other, there is significant risk and trusts must differ enough to avoid the reciprocal trust doctrine. If the lawyer drafting a SLAT is not an estate tax specialist, it would be prudent to consult with a specialist. While there are certainly potential benefits, there are significant tax law and marital risks. As with any completed gift, a transfer can still be challenged under fraudulent transfer law.

What TXdocs offers

Depending on the client's goals, several trusts already in the TXdocs library may meet the need:

A revocable living trust only avoids probate if it is funded. Assets left outside the trust at death still pass through the estate.

The bottom line

TXdocs builds forms that work under Texas law. Because § 112.035(d) would leave a self-settled trust's assets reachable by the settlor's creditors, we have not added one to the library.

For clients whose goals are probate avoidance, protecting an inheritance for the next generation, shifting assets out of a married couple's estate, or Medicaid eligibility, TXdocs has a form ready today. We welcome your questions and suggestions as we continue to build the library.