How Do Offshore Trusts Work? - SmartAsset

An offshore trust is a tool used for asset protection and estate planning that works by transferring assets into the control of a legal entity based in another country. Offshore trusts are irrevocable, so trust owners can’t reclaim ownership of transferred assets. They are also complicated and costly. However, for people with greater liability concerns, offshore trusts can provide protection and greater privacy as well as some tax advantages. To get professional assistance with these issues, consider working with a financial advisor.

Offshore Trust Basics

Offshore trusts are a type of irrevocable trust. Both domestic trusts and offshore trusts are widely used in estate planning and shield assets from being claimed by creditors or litigants who win damages in tort lawsuits. Like domestic asset protection trusts, offshore trusts can help estate planners avoid the potentially costly and lengthy probate process.

What distinguishes offshore trusts is that they are based outside the jurisdiction of the United States in a foreign country. Being offshore adds a layer of protection and privacy as well as the ability to manage taxes.

For instance, because the trusts are not located in the United States, they do not have to follow U.S. laws or the judgments of U.S. courts. This makes it more difficult for creditors and litigants to pursue claims against assets held in offshore trusts.

Similarly, offshore trusts have fewer reporting requirements than domestic trusts. It can be difficult for third parties to determine the assets and owners of offshore trusts, which makes them aid to privacy.

How Offshore Trusts Work

In order to set up an offshore trust, the first step is to select a foreign country in which to locate the trusts. Some popular locations include Belize, the Cook Islands, Nevis and Luxembourg. These countries have favorable tax and privacy regulations.

Once the country is selected, the next move is to select a trustee. To be effective for asset protection, an offshore trust must be managed by a non-U.S. citizen acting as trustee. Often, this is a trusted company based in an offshore jurisdiction.

Now it’s time to set up the trust. Drawing up the trust documents, including the deed of trust describing the use and distribution of assets placed in the trust, requires an estate planning attorney.

Finally, transfer the assets that are to be protected into the trust. Trust owners may first create a limited liability company (LLC), transfer assets to the LLC and then transfer the LLC to the trust.

Limitations of Offshore Trusts

Offshore trusts can be useful for estate planning and asset protection but they have limitations. To start with, transfers to the trust are irrevocable so assets cannot later be reclaimed by the owners.

At the same time, assets placed in an offshore trust are not necessarily invulnerable to claims by U.S. creditors and litigants. However, being in a foreign jurisdiction does make it more difficult and costly for others to pursue claims against assets in the trust. This will tend to discourage attempts to collect lawsuit damages and debts from the trust.

Also, while trusts can help with taxes, U.S. citizens who establish offshore trusts cannot escape all taxes. Earnings by assets placed in an offshore trust are free of U.S. taxes. But U.S. citizens who receive distributions as beneficiaries do have to pay U.S. income taxes on the distributions. U.S. owners of offshore trusts also have to file reports with the Internal Revenue Service.

Legal costs for setting up offshore trusts can be significant. Trusts also have to pay ongoing fees to the trustees managing the trusts. The costs of establishing and maintaining offshore trusts mean they are most suitable for people with high net worth, business owners, certain professionals such as physicians practicing obstetrics and others who are more exposed to liability.

Offshore trusts also carry special risks. Trustees have to be selected carefully in order to reduce the risk of mismanagement and embezzlement of trust funds. Corruption can be an issue in some countries. In addition, it’s important to select a country that is not likely to experience political unrest, regime change, economic upheaval or rapid changes to tax policies that could make an offshore trust less useful.

Finally, asset protection trusts generally have to be established before they are needed. Domestic asset protection trusts may provide little protection against U.S. creditors and court judgments even when set up in advance. Offshore trusts can sometimes be helpful when established after a claim is made, but they are not necessarily perfect protection against domestic claims.

Bottom Line

Offshore trusts established in foreign countries can help protect assets from creditors and lawsuits as well as provide greater privacy and some tax advantages. These trusts are irrevocable, meaning owners can’t reclaim assets placed in them and can be costly to set up and maintain. They also don’t perfectly protect against all claims and may expose owners to risks of corruption and political instability in the host countries. However, offshore trusts are helpful estate planning and asset protection tools.

Tips for Estate Planning

Understanding the right time to use a specific trust, and which trust would provide the most benefit, can be confusing. Financial advisors can help you navigate that entire process and make it simple for you. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you’re a high-net-worth individual then you need a specific type of planning for your estate. Consider using our resource on the trusts you can use to benefit your estate planning.