Under the Common Law you cannot establish a trust with your own assets, to benefit yourself, and have those assets protected from your own creditors. That common law rule—the rule against self-settled spendthrift trusts—is still the law in California and in over 40 of the other 50 states (and most countries whose laws are based on British Common Law).
In the 1980s some offshore jurisdictions repealed the self-settled spendthrift trust rule. The most prominent example was the Cook Islands, whose law was drafted by a U.S. lawyer. As a result the "APT" (asset protection trust) industry proliferated.
In the 1990s some U.S. states, e.g., Alaska, Nevada, and Delaware, repealed the self-settled spendthrift trust rule. As a result, the "DAPT" (domestic asset protection trust) industry proliferated.
A California resident can take advantage of a self-settled spendthrift trust in, for example, Nevada if the California resident has liquid assets. In that case, the trust's assets can be easily "sitused" (located) in Nevada. The trust must have a Nevada resident as a trustee. Assume a lawsuit arises in California against that California resident, and the resulting judgment creditor has no other assets to seize. The California judgment creditor takes his judgment to the Nevada courts and seeks to have it given "full faith and credit." Presumably the Nevada courts say "no," because Nevada has a stronger interest in the matter (protecting Nevada law). That gives rise to an interesting question of law under the U.S. Constitution. So far no one has decided to make that case, which leads to the suspicion that this structure is a great deterrent to creditors.
(There are other issues: For example, the IRS and a Federal bankruptcy court may not recognize these trusts.)
The structure is somewhat less attractive when the California resident tries to use a Nevada self-settled trust for California investment real property. When the California judgment creditor gets turned down by the Nevada court, that may not be the end of the road. The California judgment creditor may be able to convince a California court that it, after all, has jurisdction over the California real property. Nevada lawyers have already thought about that and recommended putting the California real estate inside a Nevada LLC. However, that is just "putting lipstick on the pig"; the real estate is still subject to the jurisdiction of a California judge.
So, is there a way to get a great deal of the benefit of a self-settled spendthrift trust for a California resident, without going outside of California? The answer is maybe.
Consider the following: Mom creates a trust for the benefit of Son. Mom is the trustee. Mom transfers $12,000 to the trust. Son has the right to withdraw, each year, up to the amount of Mom's annual gift tax exclusion which, in 2008, is $12,000 (it rises to $13,000 in 2009). Instead of withdrawing the $12,000, Son waives his right to withdraw. (This withdrawal right is referred to as a Crummey power after the now famous Ninth Circuit Court of Appeals decision.
Son's waiver of the right to withdraw makes him the "owner" of the trust for Federal income tax purposes. Rev. Rul. 67-241. As a result, any transactions between Son and the trust are ignored for income tax purposes.
Son sells his valuable investment real estate—worth $5,000,000—to the trust for a 40 year interest only note paid annually. Although his basis for tax purposes is only $1,000,000, the $4,000,000 taxable gain is not recognized on this sale because—for income tax purposes—this is a sale between Son and himself—the trust is ignored. Son receives each year 4.24% interest (the current long term "applicable Federal rate"). If Son gets sued, the creditor can only go after each annual payment as it is received. That should set up a situation where the creditor is interested in settling for pennies on the dollar.
Of course, as with all planning, this is something that should be done many years in advance of having a problem. See, for example, Bankruptcy Code Section 548(e), added by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.
Asset protection planning is an asset by asset analysis. It must be done years in advance of need. It works when done in layers, rather than relying on one structure for one asset. Many of the structures used in asset protection planning are the same ones used in estate tax planning, since the reduction in value for estate tax purposes mirrors the reduction in attractiveness to a currently unforeseeable creditor. The structure described above may be helpful in some situations.