Asset Protection

Asset protection planning involves figuring out and applying a lawful series of techniques that protect your assets from claims of future creditors. The techniques are designed to deter potential creditors from going after you, and frustrate them if they do, generally by making it difficult or impossible for future creditors to grab hold of your assets or collect judgments against you.

In cases where significant sums are involved, asset protection planning often includes setting up a series of trusts, partnerships and/or off-shore entities to hold legal title to your assets. A future creditor who recognizes how difficult it would be to collect on any judgment it may win, might decide it makes little sense to pursue a claim, or be willing to settle for pennies on the dollar.
There is a very sharp dividing line between “legal” asset protection planning on the one hand, and actions to defraud creditors, which are criminal, on the other. For that reason it is essential to have an attorney guide you through the process.

We urge all visitors to Free Advice to beware of some operators, sometimes posing as foreign trust companies, that market packages of services that they claim will protect your assets. Some of them are criminal enterprises that will steal your assets. Some are fast buck artists that will leave you with no protection. Some will open you up to serious criminal charges. Many will do all three – take your money, leave you with no protection, and set you on the road to prison.

If you are “wealthy”, “comfortable” or even if you just have some positive net worth, most likely you are concerned about keeping what you have, and preventing others from taking it. This concern is real, as there are people who will take advantage of any opportunity to take what you have.

If you are a physician you are aware of horror stories about colleagues who lost everything after being held liable for medical malpractice in amounts far beyond their malpractice insurance.

Asset protection planning enables you to employ legal techniques to prevent anyone from taking your assets. However, there are limitations as to what you can and cannot do.

Your degree of exposure to risk of liability, the type of assets you own, and your total net worth are essential factors to consider when you and your lawyer develop a strategy for asset protection. Your occupation can be one indicator of the risk of liability — for example, a pyrotechnics engineer has tremendous occupational exposure. Statistics can help you decide your risk factor, and help you to assess what kind of asset protection you need.

Insurance is the most common asset protection technique. By “transferring” the risk to an insurance company, you can usually protect your assets. But even if you buy insurance, it might not cover all possible risks that you face, or the amount you buy might not be sufficient, or the insurance company may be able to deny the claim (perhaps it could claim there were misstatements made in your application), or the insurance company may become insolvent. Asset protection planning helps you prepare for these “wild-card risks”.

Many of the traditional forms of estate planning can be used effectively as asset protection techniques. Gifts of property not intended to defraud creditors remove the assets from your estate. If your child owns the farm, it is no longer at risk from your creditors – although your son’s creditors and his spouse may pose a risk.

Retirement plans have a considerable amount of asset protection built in due to federal and state law. Spendthrift provisions in life insurance contracts and certain trusts can prevent creditor attack while the assets are outside the hands of the beneficiary. Conduction business as a corporation, using limited liability companies, limited partnerships and other business entities afford considerable personal liability protection as well as possible tax advantages.

When considering an asset protection plan, these traditional forms of asset protection should be the first ones considered. But they may not be enough.

Together with an experienced lawyer you should first perform an asset risk analysis to assess both the likelihood and extent of your exposure — in light of your occupation and other activities that could create liability – and the nature and extent of your assets, your family situation, as well as your own personal wishes and desires. You and the lawyer, perhaps with input from other professionals, would evaluate the various risks and exposures you face, and figure out how far you are willing to go to protect your assets from attack. Sometimes, and for some people, merely buying more insurance or incorporating your business will suffice. For others, more would be required to give you the level of confidence you desire.

A seasoned attorney, before filing a lawsuit, often conducts an “asset search” of the proposed defendant. The person filing the lawsuit will want to know whether it is worthwhile to sue, and whether a judgment would be collectible.

Information about you and your assets is readily available from public records. An investigative firm can quickly gather all sorts of information about you — the location of your real property, bank and brokerage accounts, ownership of automobiles and water craft, business interests, any bankruptcy petitions you may have filed, plus all kinds of other personal information for a surprisingly low fee. Thus an attorney will be able to tell if the lawsuit is worth taking, based upon the ability to collect the potential judgment. Be aware that this information is available to almost anyone who knows how to go about obtaining it.

One key to an asset search is your name. By changing the name of the registered owner of a piece of property, you can change the ownership records, and your property will “disappear” from your asset information. Simple changes, such as recording the name of the owner of a piece of real property from William Smith to Bill Smith, or putting a piece of property in your spouse’s name is not good enough. However, more innovative name changes can keep the true identity of the owner confidential.

It is important to note that changing the name of ownership may have other unintended consequences. For example, in California, if a parcel of real property is transferred to a family limited partnership, real property tax reassessment will be triggered. So if William Smith transfers his personal residence to the “Secretive Limited Partnership,” his purpose of concealing the true name of the property owner will be achieved, but the local tax collector may investigate this change of ownership to see if his property tax can be increased. In addition, changing the ownership may trigger Federal gift taxes. So before you change the ownership of your property, consider the unintended consequences.

Transferring property out of your name may also result in a loss of control. Some people will trade a lower degree of control for the benefits obtained. The amount of control that you want to have over your property will help you to determine what asset protection technique should be used. As a general rule, the less control you have over your assets the greater the degree of your asset protection.

All assets are not treated in the same manner. Some assets are exempt from attack, while others need more protection. For example, your bank account can be more easily attacked than the home you share with your spouse. Consider the difference between exempt and non-exempt property as you develop your asset protection plan.

Some examples of exempt property include:

(1) public and private retirement benefits;

(2) household furniture and furnishings;

(3) personal effects, such as clothing and jewelry;

(4) disability and health benefits;

(5) proceeds of life insurance and annuity policies;

(6) social security benefits; and

(7) tools of a trade or business.

State law governs whether property is exempt or non-exempt. When looking at your state law, be sure to check to see how much of an exemption is allowed for the particular type of property – it may be completely exempt, or exempt only up to a certain amount. For example, jewelry, heirlooms and works of art may be exempt up to $X, while 100% of the assets in your pension plan may be exempt.

Using the applicable exemptions, you and a knowledgeable attorney can structure your property holdings to turn non-exempt property into exempt property. For example, instead of putting cash into a bank account, you might decide instead to fund a retirement program.

Using the allowable exemptions is one of the most cost effective techniques for asset protection. Unfortunately, exemptions alone are insufficient to protect many of your assets; more sophisticated techniques may be required.

Depending on your state of residence, the “homestead” exemption may protect some or all of your interest in the house and the adjoining land that you occupy as a home. Creditors may not be able to force the sale of homestead property. The amount of the homestead exemption that is available is set by state statute.

If the equity in your residence exceeds the exemption allowed, one way to decrease it is to borrow against the property. You can use the proceeds of the loan to acquire additional exempt property. This strategy enables you to maximize the exemption available for a dwelling or a declared homestead.

Some state homestead examples are:

(1) California – between $50,000 and $100,000 (depending on the circumstances).

(2) Florida – up to 160 acres of contiguous land together with the improvements thereon if the homestead is located outside a municipality, or up to one-half acre of land together with the residence located thereon if the homestead is within a municipality.

(3) Texas – up to 200 acres of land, in one or more parcels, together with improvements thereon if the homestead is not located in a town or city, or not more than one acre of land, together with improvements thereon, if the homestead is located in a city, town or village. In Texas it does not matter if your homestead is worth $10,000 or $10 million.

If your retirement plan is qualified under the Federal Employee Retirement Income and Security Act (ERISA), your ownership in the plan is exempt. No third party is able to get to retirement funds held in ERISA qualified plans. This makes an ERISA qualified plan an excellent asset protection technique.

Conversely, a private retirement plan that is not ERISA-qualified is not automatically exempt from judgment creditors. This does not mean that the funds are non-exempt, it just means that formalities – such as filing a Claim of Exemption in the event of a levy – must be followed in order to protect these assets.

Self-employed retirement plans, IRAs and annuities are exempt only to the only to the extent provided by state law. For example, in California, the only non-ERISA retirement plan assets that are exempt are those necessary to provide for your support when you retire, and for the support of your spouse and dependents, taking into account all resources that are likely to be available for your support when you retire.

From an asset protection standpoint, you should consider maximizing the earnings that are placed into your ERISA retirement plan. In addition to the deferral of income tax, you obtain substantial protection against creditors while the funds remain in the retirement plan. In most instances, funds are protected until they are distributed out of the retirement plan and placed in your hands.

The legal structure of your business is extremely important. State law enables you to create a legal entity – a separate “identity” from your own person – under which you can transact business, without the risk of exposing your assets to any personal liability that might arise out of your business affairs.

Sole proprietorship affords the least amount of asset protection. Anything you or your employees do in a business that is a sole proprietorship exposes your assets.

In terms of asset protection, being a general partner can be even worse. Anything that one partner, or any employee, does in the course of the business affects all of the partners, because each partner of the of a general partnership is personally responsible for all obligations of the partnership.

To avoid risking personal liability for activities arising out of business, you need to consider other available forms of business organization which provide greater protection. Changing the form of business ownership will involve some legal work, documentation, filings with various government agencies, and have some tax impacts. They should be discussed with an attorney.

Some of the more common forms of business ownership which reduce personal liability are discussed in the sections on Corporations and Partnerships.

A revocable living trusts is a vehicle that is very helpful in avoiding probate. During your lifetime, you can transfer ownership of your assets to the revocable trust so that it is owned by the trust at the time of your death, and thus not subject to probate.

A revocable trust is not a very good asset protection technique – assets that you transfer to the trust will remain available to your creditors. However, it does make it more difficult for creditors to access these assets; before doing so, the creditor must petition a court for a charging order to enable the creditor to get to the assets held in the trust.

In addition, in most instances a revocable trust becomes irrevocable, usually upon the death of the grantor. Once it is irrevocable, a typical “anti-alienation clause” protects the assets held in the trust form being used as collateral by the trust beneficiaries. While the assets are held in the trust, the beneficiaries do not have control over the property, and any distributions are subject to the trustee’s discretion. Creditors cannot force a trustee to make a distribution to the trust beneficiaries; thus the assets held in a trust can remain outside the reach of the beneficiaries’ creditors (until distributed into the hands of the beneficiary).

A Family Limited Partnership (“FLP”) is a limited partnership that is formed to manage and control jointly-owned family property. All the requisites of a limited partnership must be followed in order to have a valid FLP. Upon formation, the assets of the family are assigned or transferred into the FLP for ownership, management and control. In most FLP’s, the parents are the general partners with a 1% interest, while the children and siblings share the remainder as limited partners. Thus the parents’ exposure to risk of loss of property held by the FLP is greatly reduced. Even if a charging order is obtained by a creditor, the partnership can limit distributions (for legitimate purposes) to reduce exposure.

An FLP also can have a dramatic effect on gift and estate taxes. By transferring assets to a FLP, general partners can use valuation discounts to lower values. With lower valuations, the amount of tax imposed can be substantially reduced.

Bankruptcy can protect your assets in several ways. In a Chapter 7 (liquidation) case, the trustee will take all your non-exempt assets for the benefit of your creditors. But sometimes you can convert nonexempt assets into exempt ones prior to filing. Exemption planning requires advice from a local attorney because rules vary between states and even between judges within a single state. If a judgment creditor (someone who has won a lawsuit against you) obtains a lien on your property, and if that lien impairs an exemption to which you’re entitled under the Bankruptcy Code, you can “avoid” that lien. Avoiding the lien wipes it out, which prevents the lien holder from seizing your property and selling it to satisfy your debt. Some states have homestead laws that protect you only from subsequent creditors. In those states, a bankruptcy filing will probably allow you to use the state homestead exemption against all your creditors, even if you file the homestead the day before the bankruptcy.

Finally, in a Chapter 13 case, your plan may allow you to pay off the arrears on your mortgage or car loan, thereby avoiding foreclosure or repossession.

For people who have larger estates, and thus larger potential creditor exposures (running into millions of dollars), “off-shore” foreign trusts can be used to provide a high degree of asset protection. Common destinations for these trusts, such as the Bahamas, Bermuda, the Turks and Caicos Islands, the Cayman Islands, the Cook Islands, Gibraltar, and the Isle of Man, have laws which tend to insulate and protect grantors. In establishing a foreign trust, you transfer ownership of your assets a trust that has only foreign trustees (with no offices or agents in the United States), which manages and administers the trust property from the off-shore sites. When your creditors begin looking for your assets, even if they discover the off-shore trust they will have to deal with the foreign trustee. The creditors may then find that there is no available remedy obtainable against an uncooperative foreign trustee. This is because the courts here in the United States have no jurisdiction over foreign trustees, and therefore are unable to provide any relief to creditors. Further, the actual geographic distance between the creditor and the trustee poses significant real barriers to creditors.

However, care must be taken prior to establishing and funding a foreign trust. The grantor should execute a statement of solvency with a balance sheet (or other appropriate financial statement) showing a positive net worth. This is essential in order to establish that you are not entering into this transaction in order to defraud creditors. Such a statement of solvency will also help those who assist you, so that they will not be attacked on the basis that they were co-conspirators in a fraudulent scheme.

Further, not all of your property should be placed into the foreign trust. You should retain locally assets sufficient to sustain your lifestyle, and transfer the remaining bulk of the estate to the off-shore foreign trust for protection. Remember it may be nearly as difficult for your family to recover your money from a foreign trust as it would be for your creditors to do so.

It is also possible to put foreign trusts, corporations, and other entities together into a limited partnership. In this case, creditors may be forced to wade through several layers of protection before they can get to your assets. Multiple entity structures serve to dissuade casual creditors as only the most sophisticated and well financed creditors have the knowledge, resources, and time to penetrate multiple entity structures. While the cost to you to establish multiple entities is increased, often the level of protection afforded is exponentially increased.

There are many federal and state statutory prohibitions regarding efforts you take to deter creditors.

Whenever you employ an asset protection technique, you must be careful not to trigger prohibitions against fraudulent transfers. A fraudulent transfer occurs whenever you transfer your property in an effort to stop a legitimate creditor from taking the asset, in order to satisfy a legitimate debt. Further, if you transfer your property away while you know of the existence of a creditor, or have reason to know that a potential creditor exists, such a transfer may be considered fraudulent. The transfer could be undone, and you could be charged with a crime and face fines, restitution orders, probation or incarceration.

Many attorneys are reluctant to assist people in certain asset protection schemes because of the fraudulent transfer rules. An attorney who participates in a fraudulent transfer scheme can be regarded as a co-conspirator in the fraud, and can be subject to the same penalties as his/her client. By creating a statement of solvency prior to the proposed transfer, you can protect the transaction from being labeled as fraudulent.

Everyone gets a “credit” against Federal Estate Taxes of $550,800 on an exemption amount of $1.5 million in 2004 and 2005 (or $2 million in 2006, 2007 and 2008). (Unless previously used up, in whole or in part, as a result of gifts of more than $11,000 to any one person in any year, or $12,000 to any person in any year starting in 2006).) Individuals and married couples with a total estate value less than the current exemption level don’t have to worry about Federal Estate or Gift Tax (the exemption amount slowly increases in steps to $3.5 in the year 2009 but then drops back to $1 million when the estate tax is reinstated in 2011).

For those who are married, there is an unlimited marital deduction. All estate taxes can be avoided upon the death of the first spouse to die. However, the surviving spouse would have to remarry and give his/her entire estate to the new spouse in order to get another unlimited marital deduction. Most people would rather their children or other relatives benefit from the estate than a new spouse and his/her family.

An estate plan can take advantage of certain tax avoidance techniques for those who have accumulated some wealth; this gets more of your property to your intended beneficiaries and less to the federal government. By using a Trust, you can establish a tax by-pass Trust at your death to hold property for your children but enable it to provide for your surviving spouse during his/her lifetime. This enables you to place up to $1,000,000 (or the current exemption amount) in a Trust for the benefit of your surviving spouse and children (which will not be subject to estate tax upon the death of your surviving spouse). Coupled with your surviving spouse’s estate and gift tax credit, this enables your spouse and you to send up to $2,000,000 (or the applicable exemption level in that calendar year) to your children free from Federal Estate and Gift Tax. (Some states also have state estate or inheritance taxes.)

A Trust is used to hold the property, and the Trustees manage the Trust estate. In the event of your incapacity your pre-appointed Successor Trustee(s) will manage the Trust estate in accordance with the instructions that you have provided. Thus, a properly prepared and funded Trust can enable you to avoid a conservatorship proceeding over your estate. Compared with the cost of a conservatorship proceeding, a Trust can be very attractive.

There is no one answer, but what you each seem to want makes sense, seems fair, and reasonable.

The first thing that may make sense is to do a pre-marital agreement that waives claims against the other’s estate. It also could provide for you to keep the property you bring into the marriage separate, so if things don’t work out neither of you loses what you started with. That’s not being “unromantic”, just realistic.

The second is to each prepare new wills. One approach is to leave your pre-marital property to your kids from the first marriage, and leave your post-marital (other than any future inheritances) property to each other.

Third, buy an inexpensive TERM life insurance policy on each other to protect each of you financially in the event of the other’s death. If you are in decent health and in your 40s-50s, it is very cheap, perhaps $800 per year for a $100,000 policy.

Fourth, agree to re-examine things in 5 years. If you still both feel the same way, leave it. But in 30 years you may feel different.

Fifth, most people’s major assets are their life insurance, IRAs and 401(k) and similar plans. Name new beneficiaries, and get the consent from the other to name your own kids as beneficiaries, waiving any spousal rights.

Sixth, for a jointly owned home, consider use of Q-TIP trusts that give the survivor the value of the other’s half for life and then at the second death, the value of one spouse’s half goes to the first to die’s kids unless it is actually needed for the survivor’s support.

While sharing title to property avoids probate after your death, naming “joint tenants” has legal and tax consequences. In effect, adding a joint tenant to your home deed means that you have now gifted a portion of that property to those named. And when you make gifts in excess of $10,000 (increased in 2002 to $11,000) in value within a calendar year to someone other than a spouse, the IRS may expect you to file a gift tax return, and in some cases pay gift taxes.

When gifting an interest in your home to anyone, you also are jeopardizing your own financial security. If the person named on the deed owns the home in its entirety, then he or she can decide to sell the home out from under you. Also, if you transfer property in some states you may lose certain property tax and other exemptions you enjoy as a senior, veteran, or homesteader.

A better idea is to create a Living Trust and name your children as beneficiaries of the Trust after you die. This has the advantage of avoiding probate, yet it gives you total control of your house prior to transferring ownership. You can also change beneficiaries if you so desire, and also provide for the circumstance if one child predeceases you.