Asset protection planning is a crucial step in your overall life and financial planning. Without a smart plan in place, your wealth accumulated over many years of hard work and diligent saving could be vulnerable.
Lawsuits, taxes, accidents, and other financial risks are facts of everyday business and your personal life. While we all like to think we’ve taken adequate steps to protect ourselves, unexpected misfortune can befall even the most careful person. In this article, we will brief you on what you need to know about this vitally important area of wealth management and financial planning.
UNEXPECTED THREATS TO YOUR ASSETS
Dangers to the safe keeping of your hard-earned assets can come from anywhere, including:
- The Internal Revenue Services and other taxing authorities
- Accident victims who can make claims against you personally or your business
- Doctors, hospitals, and other health care providers and facilities
- Credit card companies and other financial institutions
- Business creditors including your partners, customers, suppliers, or employees
- Creditors of other individuals, companies or, business associates with whom you have guaranteed financial obligations.
Although you may think that it is unlikely you will be sued, it is much more common than most people ever imagine. Consider this: According to the U.S. Financial Education Foundation, over 40 million lawsuits are filed every year. With so much on the line, it is not surprising that many financial professionals recommend starting the process as soon as possible.
What can you do to safeguard your wealth? First, identify your potential loss exposure, then implement strategies that are designed to help reduce that exposure without compromising your other estate and financial planning objectives.
ASSET PROTECTION 101
Asset protection is a set of strategies and tools used for protecting assets from lawsuits and claims by creditors. The goal of asset protection planning is to keep your property safe in the event of one or more unexpected events happening to you or your business.
Proper asset protection plans include three primary objectives:
- Lawsuit deterrence,
- Settlement negotiation leverage, and/or
- Placing your assets beyond the reach of a legal opponent.
And there are several key asset protection practices to consider:
- Insurance protection,
- Statutory protection, and
- Asset placement.
Ideally, you want to have a rock-solid asset protection strategy in place before a lawsuit, accident, or any other claims against your assets occur. After the fact could be too late, and it could mean the difference between quickly settling out of court as opposed to costly, time-consuming litigation.
THE BIG 4 ASSET PROTECTION PRACTICES EXPLAINED
No single step in your asset protection plan is a complete solution by itself but, taken together in combination, they can lay the foundation for a durable asset protection plan. Let’s look a closer look at each component.
The simplest way to cope with risk is to shift the risk to an insurance company. This should be your first line of defense. Before you do anything else, review your existing coverage and consider increasing coverage as appropriate. You should be adequately insured against:
- Death and disability
- Medical risk, including long-term care
- Liability and property loss (both personal and business)
- Other business losses
Creditors cannot enforce a lien or judgment against property that is exempt under federal or state law. While exemption planning can’t offer total protection, it can offer some shelter for certain assets.
Both federal and state laws govern whether property is exempt or nonexempt in non-bankruptcy proceedings. Generally, you can choose whether the federal exemption or the state exemption applies.
Types of property often receiving an exemption include:
- Homestead (principal residence)
- Personal property
- Motor vehicle
- IRAs, pension plans, and Keogh plans
- Prepaid college tuition plans
- Life insurance benefits and cash value
- Proceeds of life insurance
- Proceeds of annuities
Asset placement refers to transferring legal ownership of assets to other persons or entities, such as corporations, limited partnerships, and especially trusts because creditors can’t reach property that you do not own or control directly. Let’s cover each method individually.
- Shifting assets to your spouse: If you have high exposure to potential liability because of your occupation or business, it may be a good idea for you to shift assets to your spouse. Your spouse would retain the assets most at risk as his or her separate property, and you would retain assets that enjoy statutory protection — such as the homestead, life insurance, and annuities — as separate property.
- Corporations: If you own a business and are not already a corporation, changing your business structure to a corporation will make it a distinct legal entity. Incorporating your business separates your business assets from your personal assets, and your personal assets will generally not be at risk for the acts of the business.
- Limited liability companies (LLC) and partnerships (LLP or FLP): An LLC is a hybrid structure. Like a partnership, income and tax liabilities pass through to the members, and the LLC is not double taxed. Like a corporation, an LLC is considered a separate entity that can own business assets and incur debt, protecting your personal assets from other non-tax claims against the LLC.
Professionals (doctors, lawyers, etc.) often choose an LLP structure. An LLP can protect you from the professional mistakes of your partners. Your personal assets aren’t at stake if your partner commits malpractice, although your investment in the business may still be at risk.
Another option, an FLP, is a limited liability partnership formed by family members only. At least one family member is a general partner; the others are limited partners. A creditor cannot obtain a judgment against the FLP — it can only obtain a charging order, which only allows the creditor to receive income distributed by the general partner. It does not give creditors a claim on the assets of the FLP.
A trust can protect both business and personal assets from most creditors’ claims. A trust splits ownership of trust assets; the trustee has equity ownership, and the beneficiaries have beneficial ownership. There are several different types of trusts to consider.
- Irrevocable trusts: Once established, you cannot dissolve this type of trust, change the beneficiaries, remove assets, or change its terms. You lose control of the assets once they become part of the trust. But, because the assets are out of your control, they’re generally beyond the reach of creditors too.
- Offshore trusts: It’s possible to transfer assets to trusts that are formed in foreign countries, which makes it far more difficult for creditors to reach trust assets.
First, obtaining jurisdiction over the trustee in a U.S. court action is not possible. Any creditor must file suit in the offshore jurisdiction. The creditor cannot use a U.S. attorney; it must use a local attorney, who typically must be paid for legal services upfront.
Second, many offshore jurisdictions require creditors to post a bond or other surety to guarantee the payment of offshore court costs in the case the suit is unsuccessful. These obstacles have the effect of deterring creditors from pursuing offshore trusts.
- Domestic self-settled trusts: Several U.S. states enable you to set up a self-settled trust, which is a trust in which the person who creates the trust (the grantor) can name himself or herself primary, or even sole, beneficiary. The key to this type of trust is that the trustee has the discretion to distribute or not distribute trust property. And creditors can only reach property that the beneficiary receives.