Accumulating and retaining sufficient assets that can provide for a lifetime of living expenses, medical care and other financial goals is at the core of wealth planning. Asset protection planning is intended to reduce the risk of losing these assets through unexpected events. In today’s litigious society, asset protection planning has become an integral aspect of financial and estate planning. Retaining control and enjoyment over assets, while sheltering those assets, to the extent allowed, from the claims of creditors is the key focus of these techniques.
There are three basic asset protection techniques: insurance, statutory protection and asset placement. None of these techniques is a complete solution by itself, but may make sense as one limited component of an asset protection plan.
Proper insurance coverage can significantly reduce your personal risk by shifting some it to an insurance company. Umbrella insurance provides protection from many personal injury claims above the liability limits set by your homeowners or auto insurance. If you’re a business owner, it’s also important to ensure your company is adequately insured for both liability and property loss.
Review your existing coverage and consider purchasing or increasing coverage, as appropriate. You should be adequately insured against:
- Death and disability
- Medical risk, including coverage for long‐term care
- Liability and property loss (both personal and business)
- Other business losses
If you are expecting an inheritance, you may want to speak with the person leaving you the inheritance to suggest that it be left in trust rather than receiving it outright. If an inheritance is left outright, it will be exposed to existing creditors and may remain exposed to potential future creditors. Conversely, an inheritance received in a properly structured trust could be shielded from creditors and remain free from future estate tax for the portion of the unconsumed inheritance.
2. Statutory Protection
Another potential hidden gem for protection is maximizing your use of assets that are generally exempt from creditors’ claims. Creditors cannot enforce a lien or judgment against property that is exempt under federal or state law. While exemption planning cannot 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. When looking at exemption laws, be sure to find out how much of an exemption is allowed for a particular type of property, as it may be completely exempt, exempt only up to a certain
amount or restricted in some way.
For instance, your interest in an IRA (Individual Retirement Account) or Roth IRA is exempt from creditors in many states. This does not typically include inherited IRAs — unless specifically protected under state law, which is the case in Ohio and Florida, among others. And other states, such as Michigan, have not yet explicitly addressed the protection of inherited IRAs. ERISA (Employee Retirement Income Security Act) qualified pension plans also are generally exempt. Therefore, your retirement plan at work should be exempt from creditors until you retire and begin withdrawals from the account. Also, life insurance and annuity contracts typically enjoy an unlimited exemption from creditors in Ohio, Florida and Michigan.
In certain states, such as Florida and Michigan, a husband and wife can help protect their assets by owning their joint property as tenants by the entirety and not as joint tenants with rights of survivorship; in this situation, the creditors of one spouse cannot reach property held as tenants by the entirety, but they can reach assets held in other forms of joint ownership. If you live in a state where holding property as tenants by the entirety may be beneficial to protecting your assets, speak with legal counsel to execute the appropriate agreement.
3. Asset Placement
Asset placement refers to transferring legal ownership of assets to other persons or entities, such as corporations, limited partnerships and trusts. The rationale behind this technique is simple — creditors cannot reach property that you do not own or control.
Repositioning assets to make it legally difficult for potential future creditors to reach them does not mean hiding assets or defrauding creditors. If a court finds that your asset protection plans were made with the intent to defraud, it will disregard those plans and make the assets available to creditors.
To avoid violating the fraudulent transfer laws, consider the following guidelines:
- Ensure your plans are made for legitimate business purposes or to accomplish legitimate estate planning objectives.
- Carefully document the legitimate business and estate planning purposes of any arrangements you make.
- Put your plans into effect before you have any problems with creditors.
- Do not implement a plan at a time when a lawsuit is imminent or pending, or at a time when you have an outstanding debt that you believe you may be unable to pay.
A best practice is to separate personal and business assets with the intent of separating their respective risks. For example, by placing business assets in a limited liability company, family limited partnership or other corporate structure providing personal liability protection, you may be able to shield your personal assets from business or professional liability litigation.
Although liability protection is a desirable goal for business owners, some businesses are unable to achieve it. These businesses are typically professional practices where the owners remain personally liable for their own malpractice or negligence under state law. State law often restricts physicians, attorneys, accountants and other professionals from forming organizations that would limit their personal liability for their own malpractice. However, many states have created variations of liability protection for professionals to protect them from vicarious liability. These business forms include professional corporations, limited liability partnerships and limited liability companies.
For married couples, balancing assets significantly helps obtain the maximum applicable exclusion amount for each spouse while simultaneously removing assets from a potential debtor’s estate. Alternatively, it may be more beneficial to title assets in the name of the spouse who has less creditor risk. If you have high exposure to potential liability because of your occupation or business, it may be advisable for you to shift assets to your spouse. Your spouse would retain the assets that are subject to the exposure 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. Furthermore, shifting assets to a spouse or children may help accomplish other estate planning goals.
To avoid complications in the event that your marriage ends in divorce, both you and your spouse should agree to the division of assets in writing. This is especially important in community property states, since property and income acquired or earned by spouses during their marriage while living in a community property state is considered to have been acquired or earned by both equally — regardless of which spouse actually contributed or earned it, with limited exceptions.
In addition to these basic asset protection strategies, there are many more sophisticated techniques available. Potential strategies include Domestic Asset Protection Trusts (DAPT), QTIP trusts (Qualified Terminable Interest Property), Qualified Personal Residence Trusts, Family Limited Partnerships and spendthrift provisions.
Work directly with your financial and legal advisers to help protect your assets from unexpected events and unwelcome creditors.
Heather Welsh is a Director of Wealth Planning at Sequoia Financial Group, LLC. Contact her at firstname.lastname@example.org to discuss this topic further or visit www.sequoia-financial.com.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.
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