One of the primary objectives of estate planning is protecting your assets from unreasonable creditors’ claims, frivolous lawsuits or financial predators ― the reason being that you want to pass as much of your wealth to your family as possible.
Both offshore and domestic trusts can be highly effective vehicles for protecting wealth, but they can be complicated and expensive. The good news is that there are basic yet effective tools you can implement to protect your hard-earned wealth.
Basic asset protection strategies
Some of these strategies involve transferring assets to another person or entity, or changing the way property is titled.
Buying liability insurance. For many people, insurance is the first line of defense against liability claims that expose their assets to risk. It includes personal or homeowner’s liability insurance, as well as professional liability insurance for doctors, lawyers and other professionals who are common targets for lawsuits.
Making lifetime gifts. The most effective asset protection strategy may also be the simplest: giving your assets away to your children or other loved ones. After all, a creditor can’t come after assets you don’t own. The disadvantage of this approach, of course, is that you must relinquish control over the assets. But if you’re comfortable parting with assets during your lifetime, gifts are a great way to place them beyond the reach of your creditors.
Using tenancy by the entirety. Many states permit married couples to hold their home or other real estate as “tenants by the entirety.” This form of ownership protects assets against claims by either spouse’s separate creditors. So, for example, it can be effective when one spouse is exposed to professional liability risks. It doesn’t, however, protect couples against claims by their joint creditors. Tenancy by the entirety, if available, is a good option for people who aren’t comfortable transferring title to their spouses.
Including assets in retirement accounts. Qualified retirement plans — such as 401(k), 403(b), and 457 plans, as well as certain pension and profit-sharing plans — are excellent asset protection vehicles. IRAs offer more limited protection. Assets held in most qualified plans enjoy unlimited protection from creditors’ claims — both in bankruptcy and outside of bankruptcy — under the Employee Retirement Income Security Act.
IRAs generally are exempt from creditors’ claims in bankruptcy up to a specified threshold. This limit doesn’t apply, however, to amounts rolled over from a qualified plan to an IRA or to future earnings on those amounts within the IRA. There’s a notable exception for inherited IRAs, in that the Supreme Court recently decided that those assets aren’t protected if you inherited the IRA from someone other than your spouse.
Outside the bankruptcy context, the level of asset protection for IRAs varies depending on applicable state law.
Creating a family limited partnership (FLP) or family limited liability company (FLLC). Transferring assets to an FLP or FLLC can be an effective asset protection strategy, especially if you wish to retain control over a business or other assets. To take advantage of this strategy, set up an FLP or FLLC, transfer assets to the entity, and either give or sell ownership interests to your children or other family members.
You can maintain control over the assets by retaining a small (for example, 1%) general partnership interest in an FLP or acting as manager of an FLLC. Limited partners in FLPs — as well as managers and members of FLLCs — aren’t (except in very limited circumstances typically involving some personal wrongdoing) personally liable for the entity’s debts. And their personal creditors cannot reach the entity’s assets. Instead, these creditors are limited to obtaining rights to any distributions received by the limited partner or LLC member.
Beware of fraudulent transfer laws
Most states have fraudulent transfer laws, which prohibit you from transferring assets with the intent to hinder, delay or defraud any creditor, including a probable future creditor. Typically, these laws also prohibit “constructive fraud,” which is when you transfer assets, without receiving reasonably equivalent value in exchange, and you’re insolvent before or after the transfer.
To ensure that your asset protection efforts are successful, be sure that you’re solvent before and after any transfer and that you transfer assets at a time when there are no actual or potential creditors’ claims on the horizon.
First things first
Before considering your asset protection options, conduct a risk assessment to get a handle on your level of exposure. The results can help you determine which asset protection strategies to implement. Your ASL advisor can help with the risk assessment.