Pros and Cons of Foreign Trusts

Foreign trusts, often referred to as offshore trusts, are trusts governed by the laws of a foreign country rather than the United States.

They are one of the most effective asset protection tools, but they come with noticeable drawbacks.

What Is a Foreign Trust?

A foreign trust is a trust formed under the jurisdiction of a country outside the United States.

It involves transferring assets to a trust managed by a foreign trustee in an offshore jurisdiction with laws favorable to asset protection.

By moving assets and the trust’s administration offshore, the trust places those assets beyond the direct reach of U.S. courts and creditors.

Foreign trusts used for asset protection are almost always irrevocable and self-settled. The trustmaker gives up direct control of the assets to the foreign trustee, who has the legal discretion to refuse any distribution ordered by a U.S. court.

The main strength of a foreign trust is that its assets and trustees are beyond U.S. jurisdiction.

Advantages of Foreign Trusts

1. Strong Asset Protection

The main advantage of a foreign trust is the ability to keep assets outside the jurisdiction of U.S. courts. A creditor with a U.S. judgment must start a new legal action in the foreign jurisdiction.

Countries like the Cook Islands do not recognize U.S. judgments. It is unlikely that a creditor will attempt this even with knowledge of the debtor’s foreign trust.

2. Privacy and Confidentiality

Foreign trusts are not publicly searchable. Jurisdictions promoting foreign trusts have strict confidentiality laws that protect information about the trust, its beneficiaries, and its assets.

3. Estate Planning

Like domestic living trusts, foreign trusts can be used to pass assets to beneficiaries without probate. Many foreign jurisdictions permit perpetual or long-term trusts, allowing for multi-generational wealth transfers.

4. Stronger Protection than Domestic Trusts.

In our experience, domestic asset protection trusts are generally ineffective for U.S. citizens who do not reside in the state where the trust is established.

Domestic trustees are subject to U.S. court orders. A foreign trustee is not.

Disadvantages of Foreign Trusts

1. High Costs

Foreign trusts are expensive, both to establish and maintain annually. A foreign trust structure set up for asset protection costs $15,000 to $20,000 to set up. Annual trustee fees are between $3,000 and $5,000 per year.

These high costs are made worse when some trust companies or attorneys push for additional features that most people do not need.

Because of the costs, a foreign trust would be overkill for someone with moderate assets and no realistic creditor threats. Especially if they live in a state like Florida, which offers various debtor-friendly exemptions.

2. Loss of Direct Control

With a foreign trust, the settlor must relinquish direct control of the trust assets. The trustmaker cannot serve as the sole trustee.

In practice, the foreign trustee will comply with your investment and distribution desires, but it still takes longer and requires more coordination than doing it yourself. Plus, the trustee will charge hourly for time spent handling your requests.

3. Reporting Requirements

Foreign trusts must be reported to the IRS. Certain foreign accounts must also be reported. The IRS assesses penalties for noncompliance.

4. Contempt of Court Risk

Even with the protection of foreign trusts, U.S. courts can still order settlors to repatriate trust assets. Failure to comply, even due to impossibility, does not usually result in jail for contempt, but it has before.

5. Limitations for U.S. Real Estate

Foreign trusts are less effective for protecting U.S. real property. Liquid assets and investments can be moved fully offshore, but you can’t move the land. Equity stripping in a foreign trust structure can be effective, but it is very expensive when done properly.

6. Bankruptcy Limitations

Foreign asset protection trusts are not effective asset protection solutions in bankruptcy. Bankruptcy courts exert worldwide jurisdiction over your assets.

Bankruptcy courts can reach assets transferred to a foreign trust within ten years if done to hinder creditors.

When setting up a foreign trust, it is best if the trust attorney has expertise in bankruptcy law and has experience defending against involuntary bankruptcy petitions.

Choosing a Foreign Trust Jurisdiction

The Cook Islands is the most well-known jurisdiction for foreign trusts. It has strong debtor-friendly laws, a short statute of limitations, and a long history of favorable court decisions.

That being said, the choice of jurisdiction is less important than the choice between a domestic and foreign trust. The key step is the transfer of assets to a foreign trustee company not subject to U.S. court orders.