There are many benefits to titling property in a joint revocable living trust (RLT). There also are many benefits to holding property as tenancy by the entirety (TBE). However, with respect to the benefit of protecting the property from the interests of creditors, these two forms of title can be very different. When property held as TBE is placed in a joint RLT, the differences between the two forms of title can affect the benefits derived for married couples. This article explains the differences in creditor protections for property held in a joint RLT and as TBE. If you are married and hold property as TBE, you should consult with an experienced attorney before undertaking any estate planning of your property.
Is your property protected from creditors?
If you are married and own property, you probably have considered how to protect your property from the interest of creditors. These can include:
- Judgment or lien holders to which you are liable through litigation
- An ex-spouse from whom you are divorced
- Interest holders in bankruptcy proceedings
Creditors with an interest in your property may be your individual creditors, creditors of your spouse or joint creditors of both you and your spouse.
Creditor protections are generally determined by state law. Thus, whether your property is protected from the interests of creditors may vary from state to state. Your estate planning attorney can explain the creditor protection laws that are applicable in your state. Generally, however, certain types of property are normally protected from the interests of creditors. These may include:
- Qualified interests in IRAs (inherited IRAs are not protected from bankruptcy)
- Qualified retirement plans
- Qualified profit-sharing plans
- Qualified homestead property
- Qualified life insurance policies
Other types of property generally are not protected from the interests of creditors. These may include:
- Property subject to the creditors of both spouses
- Property retained by a surviving spouse
- Non-qualified insurance proceeds, investment accounts and personal property
- Inherited IRAs
- Joint or individual bank accounts
- Individually owned real property in excess of an applicable homestead exemption
- Property held in certain non-qualified trusts (i.e., self-settled spendthrift trusts, domestic asset protection trusts not excepted under state law)
- Property fraudulently transferred to avoid creditor liability
Whether your property may be protected from the interest of creditors also may depend on how you hold title to your property. Two common ways by which married persons hold property that can affect whether property is protected from creditors are by holding property in a revocable living trust (RLT) or by holding property as tenancy by the entirety (TBE).
What are the benefits of holding property in a revocable living trust?
When developing an estate plan, it is not uncommon to consider transferring property to an RLT. Some of the benefits of holding property in a joint RLT include:
- Avoiding the expense and possible delay of probate
- Avoiding ancillary probate of real property located in other jurisdictions
- Ease of management and subsequent administration
- Managing property if the grantor becomes disabled or incapacitated
Despite these common benefits, however, a joint RLT does not necessarily protect your property from the interests of creditors. Generally, creditors may have a legal interest in property that remains in the grantor's estate or over which the grantor may exercise dominion and control so as to retain an interest in the property. If a trust is revocable, the grantor retains the power to revoke the trust and, therefore, retains control over the trust property. Accordingly, the trust property is considered part of the grantor's estate and may be accessible to qualified creditors.
A grantor's retention of power over trust property may also occur through the powers to appoint, amend terms, name beneficiaries and retain other powers over the administration or distribution of trust property. To remove trust property from the access of creditors, the grantor must relinquish all dominion and control over the property, such as by the relinquishment of a completed gift. This normally may be accomplished with an irrevocable trust, but not a joint RLT. Instead, while both spouses are alive, the assets in a joint RLT trust may be accessible by the creditors of either spouse. And after one of the spouses dies, the surviving spouse generally retains full access to the assets of the trust, thereby making the assets fully accessible to the creditors of either the deceased or surviving spouse.
What are the benefits of holding property as tenancy by the entirety?
Another common way for married persons to hold property is by holding property as TBE. This means that the property is jointly owned by both spouses, as one entitled entity, with each spouse owning an undivided, one-half interest in the property, possessing a present right to use the property and retaining a survivorship interest in the property. Such title assures that only joint creditors of both spouses may attach a judgment to the property. The benefits of TBE include the following:
- During marriage, neither spouse can convey property without the consent of the other spouse
- Creditors of one spouse cannot attach or lien the property (except the IRS)
- When one spouse dies, the other spouse retains ownership of the property outright, without going through probate to obtain title to the property
Thus, although TBE does not offer the ancillary benefits of a joint RLT, TBE is a much more effective method for creditor protection than a joint RLT.
In the United States, about half the states recognize title held as TBE. Approximately two-thirds of those states that recognize TBE property provide creditor protection for both real and personal property, whereas other states limit creditor protections for TBE to real property. Additionally, states vary with respect to the nature of the property to which TBE protections may apply. For example, some states allow shares of stock of a cooperative apartment corporation to be held as TBE, but other states may not. Your estate planning attorney will determine whether any of your property may be held as TBE under applicable state laws and whether the creditor protections afforded by TBE may be advantageous to your long-term estate planning goals.
Keep in mind, however, that because TBE protections for spouses are defined by state law, TBE property may not be protected from interests held by the IRS, bankruptcy courts or those interests held outside of marriage, such as those of divorced or surviving spouses. Generally, TBE protections will terminate upon the following:
- Both spouses agree to terminate the TBE and divide the property otherwise
- One spouse conveys his or her interest in the property to the other spouse, causing the recipient spouse to become the sole owner of the property
- One spouse dies and the surviving spouse retains sole ownership of the property
- The parties divorce and, by operation of law, the property converts to a tenancy in common
You should obtain the advice of an experienced estate planning attorney before titling property as TBE or relying on the creditor protections that may be afforded in your state.
What happens when property held as tenancy by the entirety is placed in a joint revocable living trust (RLT)?
There are benefits to holding property in a joint RLT and as TBE. In the modern estate planning world, particularly with the portability of spousal tax exemptions, joint RLTs are a primary tool for accomplishing long-term estate planning goals of married couples. However, when property that is held as TBE is used to fund a joint RLT, a significant question arises as to the application of creditor protections afforded (or not afforded) under each method of ownership. States vary widely as to the effect of this combination of ownership interests, which can jeopardize the creditor protections otherwise afforded through TBE property.
What options are available to protect TBE property from the interests of creditors?
Common joint RLTs are not necessarily effective estate planning tools for protecting assets from creditors. However, depending on specific estate planning needs, there are a variety of asset-protection estate planning steps that married parties can take to protect property held as TBE from the interests of creditors. These may include the following:
- Invest sufficiently in your primary residence to obtain applicable homestead protection, where available
- Purchase qualified life insurance or liability insurance
- Fund retirement accounts, including IRAs, 401(k) and ERISA-qualified accounts
- Transfer ownership of assets to other creditor-protected entities, such as limited liability companies or family limited partnerships
- Transfer sole ownership of assets to the spouse less likely to be subject to future liability (but be mindful of the attendant risks of death or divorce, which may defeat the purpose of such transfers)
If trusts are a necessary part of your estate plan, consider with your estate planning attorney the types of trusts that may afford greater creditor protections. These may include:
- Irrevocable trusts (as opposed to RLTs)
- Individual trusts (as opposed to joint RLTs)
- Absolute discretionary trusts (affecting complete divestment of the grantor)
- Specific trusts expressly qualified by state law (i.e., qualified self-settled spendthrift trusts or qualified domestic asset protection trusts)
- Statutory Tenancy by the Entirety Trusts (STETs)
What is the most important step to protect TBE property from creditors?
The most important step in developing an estate plan that anticipates and protects against the potential for creditor liability is to consult with a licensed estate planning attorney who can explain the current laws applicable to joint RLTs and TBE property. Your attorney will help you identify and understand the benefits and disadvantages of each of these forms of property ownership and can help you to protect your property from the interests of your creditors and the creditors of your spouse.