This article is the eighth in a series of nine articles explaining the Eight Goals of a Good Estate Plan. In this Article we will explain how to use Family Limited Partnerships and Irrevocable Trusts to protect assets from creditors in Illinois.
In Illinois, a married couple can own their primary residence in a manner called“Tenancy by the Entirety.” Creditors of only one spouse cannot place a lien on property held in Tenancy by the Entirety. This method of ownership is reflected on the deed to the property. It is restricted to married couples’ primary residences. Ensuring that your residence is held as tenants by the entirety, rather than joint tenancy or tenancy in common is a good first step in protecting your assets from creditors.
For married couples with joint debt, or with multiple properties, Family Limited Partnerships (“FLPs”) and Family LLCs can protect assets that Tenancy by the Entirety cannot. In order to implement the Family Limited Partnership strategy, you must transfer an asset from ownership by you as an individual to ownership by a Limited Partnership entity registered with the Illinois Secretary of State.
The drawback to a limited partnership is that, in order to make it effective, you must name your children, or some family member other than your spouse as partners in the partnership, and therefore partial owners of the property owned by the partnership.
Typically, the parents (the true owners of the property) will be the only general partners, who have the right to control the property, and both the parents and children will be limited partners, with rights to payment of profits upon the sale of the property. Typically, the children will have a very small percentage ownership interest with no rights of control.
If a Family Limited Partnership is properly established, creditors of the parents cannot place a lien on any real estate held by the partnership. Instead, they will only be entitled to a charging order, which entitles them to payment of profits from the partnership assets until their debt is satisfied.
A Family LLC operates in a similar way, except that instead of general partners and limited partners, we have managers and members.
Irrevocable Trusts can be used to permanently give up some of your ownership rights in the property in order to protect the property from your creditors, while retaining some control over the property. The rule of thumb is that the more rights of ownership that you transfer to a third party (like your children), the more likely the trust will be to protect the assets it owns from your creditors. Unlike Revocable Trusts, which are a typical vehicle for an estate plan used to keep your assets out of probate, the terms of Irrevocable Trusts are difficult, if not impossible, to amend after they have been drafted.
A common example of the use of an Irrevocable Trust for asset protection is to provide that you have the right to continue to possess the property for the rest of your life, while giving your children (or some other family member) the present right to inherit the property when you pass away. This is called a life estate.
A life estate created by an Irrevocable Trust is different from an inheritance created by a Revocable Trust or a Will. A Revocable Trust or a Will gives your children apotential future right to inherit the property. This potential future right does not materialize until you actually pass away. It is only a potential right, not an actual present right, because between today and that time you pass away, you can change your Revocable Trust or Will freely, preventing the potential right from ever materializing. An Irrevocable Trust, on the other hand, gives your children a present actual right to receive the property when you pass away. That right cannot be taken away without your children’s consent. Importantly, this means that if you give yourself a life estate in your property, you will no longer be able to sell it or encumber it with loans without your children’s consent. It is this division of the interest in the property that protects the asset from creditors’ liens. The property is no longer fully yours, so it cannot be sold for the benefit of your creditors.