Family Limited Partnerships and Irrevocable Trusts

In our past articles on estate planning, we have primarily discussed the Revocable Trust, which allows your estate to avoid probate but does not protect your estate from creditors.  If you are interested in using estate planning in order to shield certain assets from your creditors, two other vehicles may be useful: (1) the Family Limited Partnership; and (2) the Irrevocable Trust.

In our hour of need, let’s call on the Avengers to help make estate planning interesting, which is on par with saving New York from Loki in terms of difficulty.  In order to develop the super-soldier serum that would eventually imbue Captain America with his powers, Howard Stark borrowed several million dollars.  Although Howard has every intention and expectation of repaying the loan, he would like to make sure that his prized asset, Stark Tower, as well as his savings account, are protected from collection by his creditors in the event of a default.  His primary concern is ensuring that these assets are included in Tony’s inheritance.

Family Limited Partnerships

One way that Howard can protect his assets from his creditors is to transfer ownership of Stark Tower and his savings account into a Limited Partnership with Howard as a general partner and his son, Tony, as a limited partner.  If Howard does this, his creditors will not be able to access partnership property.

Howard’s creditors’ remedy would be to obtain a charging order requiring that any disbursements from the partnership to Howard be paid directly to the creditors.  If a judgment is entered against Howard, Howard can preserve Stark Tower and his savings account by avoiding disbursements to himself.  The downside of this strategy is that Howard will be required to observe certain formalities, such as an operating agreement.  Howard would also have to give up some interest in the property to Tony, even if it is only a future interest.

Irrevocable Trusts

Another option for Howard, which can be used either in conjunction with the Family Limited Partnership or independently, is to place Stark Tower and Howard’s savings account in an irrevocable trust.  Again, in this scenario, Howard would have to give up some sort of control or future property interest.

This is usually more palatable with respect to real estate than bank accounts.

For example, Howard could give himself the right to live at Stark Tower for a limited number of years, at which point the property reverts to Tony, the beneficiary of the trust.  Another option would be to provide the trust with the right to purchase the property at a price equal to the mortgage, which would supersede any creditors’ claims, making the property valueless to creditors.  The downside to both of these options is that they would inhibit Howard’s ability to sell the property.

If Howard wishes to protect his bank account through an irrevocable trust, he will be required to make Tony the beneficiary, meaning the funds in the account must be used for Tony’s benefit, not for Howard’s.

Bottom line:  Both the Family Limited Partnership and the Irrevocable Trust require you to give up some rights in the property that you wish to shield from creditors.  The rule of thumb is that the more control of the property that you give up, the greater the protection these mechanisms provide.