A common myth is that asset protection planning is only for the wealthy and for professionals susceptible to malpractice claims, such as doctors or lawyers. This is not the case. In today’s litigious society, it seems that anyone can be sued for just about anything.
Some also view asset protection planning with a skeptical eye, believing there is a moral obligation to pay one’s debts and viewing this type of planning as immoral because it prevents the collection of a judgment by a creditor. In reality, the U.S. justice system is unpredictable. With expanding theories of liability and the possibility of being perceived as having “deep pockets,” it is important for everyone with assets to properly protect them.
It is important to note that asset protection is not about avoiding taxes, keeping secrets, hiding assets, or defrauding creditors. Asset protection planning is aimed at providing an incentive for settling a claim, improving your bargaining position, offering options when a claim is asserted, and ultimately, deterring litigation.
Take Advantage of Basic Asset Protection Strategies
You should already be taking advantage of the first line of defense – insurance. Depending upon your particular circumstances, you should consider homeowner’s, automobile, business, malpractice, long-term care, and umbrella policies. You should regularly review your policies to determine if the amount of coverage is in line with your current net worth. You should also review them during each renewal period to confirm that the coverage is still adequate and the benefits have not been stripped to maintain your current premiums.
Also, if you are still working, you should maximize contributions to your 401(k) since federal law protects these assets in bankruptcy. If you are retired, assets held in an IRA are also protected under federal bankruptcy law (subject to certain limits). Further, if you are married, real estate and personal property may be held by both spouses as “tenants by the entirety” if recognized under applicable state law, exempting it from bankruptcy proceedings if only one spouse is the debtor. Finally, annuities and the cash value of life insurance may also be protected under applicable state law.
Digging Deeper into Sophisticated Asset Protection Strategies
Because every strategy has its downsides, it is important not to rely solely on these basic approaches. The risks posed by lapsed policies and limitations on state exemptions in bankruptcy necessitate further planning to fully protect your assets. In particular, if you are a landlord or real estate investor, own a business, work in a high-risk profession, or have accumulated or inherited a significant amount of unprotected property, then you should consider more advanced asset protection planning. This will typically involve transferring some or all of your ownership interest in the protected property to another entity such as a trust to make it more difficult for a creditor to stake a claim. Your spouse, children, and grandchildren should also not retain ownership interests. Instead, arrangements should be made for them to receive payments for their health, education, maintenance, and support.
Sophisticated planning is complicated and will often require several layers of protected entities, such as limited liability companies (LLCs and one or more irrevocable trusts. In addition, although U.S.-based LLCs and irrevocable trusts, when correctly implemented, offer significant protection, depending upon the amount of your wealth and exposure to liability, the use of foreign entities may be warranted.
Irrevocable trusts can be used for your benefit (self-settled) and/or the benefit of your family (third party). If you transfer your assets into a properly formed and administered self-settled trust, you can retain a beneficial interest, while denying your creditors access to those assets. Although state law governing self-settled asset protection trusts varies widely in the states where they are recognized, the law generally requires the following:
- The trust must be irrevocable.
- At least one trustee must be a state resident or a corporation authorized to do business in the state.
- Some trust assets must be located in the state.
In addition to these requirements, U.S. self-settled asset protection trust law differs on “exception creditors” (such as an ex-spouse who is owed alimony or a child who is owed child support who can still access the trust assets) and statutes of limitations applicable to preexisting and future creditors (1.5 to 6 years). Because the law is continuously evolving in this area, it is important to work with an experienced attorney to ensure the appropriate steps are being taken.
A third-party trust is a great way to provide inheritance protection for every member of your family. In this day and age, characterized by high divorce rates, lawsuits, and bankruptcies, leaving an inheritance outright is risky. Additionally, it could end up in the hands of your child’s spouse instead of benefiting your children or grandchildren.
Final Considerations
Unfortunately, in our litigious society, asset protection planning is essential for people of any means. If it is done correctly, asset protection planning is not only legal but also completely ethical. Contact us to review your assets and advise you regarding all of your options for implementing and maintaining a plan that will protect you and your family.