Business planning and estate planning[i] are two major areas in which the question of asset protection is raised by investors and will often be incorporated in the financial plan and accompanying advice. The primary goal of asset protection planning is to protect one’s wealth from the reach of potential future creditors, whether your creditors or creditors of your heirs and beneficiaries. Such planning is typically engaged in as a part of the creation of one’s broader overall financial strategies, including the operation and succession of business, tax planning, retirement cash flows and ultimately leaving an estate.
Very generally, asset protection planning is the process of analyzing one’s financial situation to determine the best course of action to ensure that your various financial goals are served first and that all legitimate means for protecting your assets are taken. This ranges from transfer of assets to trusts to the purchase of insurance to the creation of limited liability entities to hold and manage assets. It is an area that can be very complex and which is extremely important to wealthier investors and business people, though almost anyone may take advantage of asset protection planning in the larger context of financial advising.
Why Do You Need to Consider Asset Protection?
The potential sources of liability, which in turn likely reduce that portion of your assets and resources expended in covering those liabilities, are numerous and may apply to almost anyone, regardless of a particular level of wealth. Consider, for example, the following partial list of areas of liability that may apply to clients: accidents involving vehicles, your home or business which result in personal injury and/or property damage; contract disputes and claims; divorce; environmental liability and many more.
Given the many potential sources of liability, it seems clear that being able to limit the amount of potential liability for any or all of these items should be helpful to people with regard to meeting their financial goals and objectives. In the best case, one should address these issues long before any liability actually arises, limiting the amounts that are within reach of creditors and maximizing amounts devoted to our goals. Where there is an existing lawsuit or formal claim, the potential for planning is greatly reduced but not eliminated.
What should you know about asset protection planning? Probably the most important thing to know is whether you could benefit from such planning and then work with an attorney well versed in the area and your financial advisor. That is how we will know the asset protection planning that takes place is both appropriate and coordinated with our overall financial goals and objectives.
What Doesn’t Work to Protect Your Assets?
First, there are some common misconceptions about asset protection and you should be aware of them so that your expectations are reasonable and able to be met. A lifetime revocable trust, as a practical matter, provides no protection from creditors since they can look through the trust to you. Although many types of creditor claims may be dischargeable in bankruptcy, thus protecting some assets from those creditors, a variety of other claims are not dischargeable, leaving your assets open to claims for taxes, for child support and alimony, for most criminal acts and intentional torts (civil wrongs) and the like. Note that many of these types of claims may overcome other asset protection strategies, such as spendthrift trusts, as well. However, certain types of assets generally provide some protection against creditors, including qualified retirement plans such as the IRA, 401(k) and 403(b), while even life insurance cash values or proceeds and annuities may be unreachable by creditors in many cases.
Second, doing nothing about asset protection may be far worse than making the attempt to incorporate some level of asset protection in your financial planning. Acting before there is a need to engage in asset protection planning is a part of a sensible approach to financial strategies generally and also allows greater flexibility in planning.
Third, using only an asset protection trust in your plan may be insufficient. These trusts may not provide the levels of protection claimed by many of those offering them and great care should be exercised in working with these entities. A client should be encouraged not to place all of their assets in this basket. This is because domestic asset protection trusts – largely self-settled spendthrift trusts – although permitted in an increasing number of few states, offer protections which vary and which may not be fully recognized or enforced by other states. Foreign asset protection trusts have also come under high scrutiny and may not provide the expected protection, particularly where the requirements are not fully met.
A final, related consideration is that each client situation is different and the level and type of asset protection necessary will vary. This is where it is important to involve at least one expert besides your financial adviser in the advice process, usually one experienced in asset protection planning as well as debtor-creditor law. Such a team approach helps to keep the advice process focused on you and your needs.
How May You Protect Your Assets?
One basic asset protection planning technique is the acquisition of insurance against the risks associated with your personal or business activities. These activities may range from simply operating a business to owning real property to operating vehicles or machinery and so on. Although legitimate claims may never arise out of these activities, it is important to have insurance protection for the risk of an occurrence where liability may attach. When a person owns reasonably adequate coverage (a topic not in scope for this article) then creditors and their attorneys are likely to settle their claims within the limits of the insurance policy, and the courts tend to follow this approach, though sometimes juries fail to act reasonably in entering their awards. Of course, insurance will not provide for all cases but does provide a reasonable starting point for many types of potential liability.
The limited liability company – or partnership – is currently in vogue as a method of asset protection planning, in addition to its other virtues. Typically, where a limited liability company (LLC) has multiple members, creditors of one of the members are limited to a charging order as their sole remedy with respect to the LLC. A charging order is basically the right of a creditor to reach the interest in the LLC held by the debtor (partner or member). This right is limited to the right to take distributions to which the debtor would otherwise be entitled and no more. It is a limited right, akin to an assignment, and may not be particularly attractive to creditors, hence the desirability of the LLC as an asset protection device. The underlying concept of the charging order is intended to protect the members of the LLC from being forced to accept a creditor of one of them as a partner or member of the LLC in lieu of the debtor partner or member. It is intended to protect the other members of the LLC in their operation of the entity.
The domestic asset protection trust is a popular vehicle offering asset protection. If you reside in a state that encourages and allows self-settled spendthrift trusts and your assets and even the trustee are all located within the state, then the likelihood of the trust being enforced in the state’s courts is reasonably high. This is limited protection however, and great care should be given to ensuring that your activities are confined to states recognizing and enforcing such trusts. It might help to consider using such a trust as only one part of an asset protection plan to ensure that not all assets are at risk. It might be useful to note that the validity and effect of these trusts has not been thoroughly litigated in the courts so that one does not really know the extent of the protections available.
Other types of asset protection planning that may prove useful include a broad variety of trusts in which you as the grantor retain no interest or only a limited interest that is outside your control. To the extent you have retained an interest in the trust, however, creditors generally can reach your right to distributions from the trust or other similar interests. These trusts generally are implemented as a part of a comprehensive estate plan or business plan that also includes asset protection planning. Note that these trusts should not be confused with asset protection trusts (foreign or domestic) or with the self-settled spendthrift trusts allowed in some states.
Asset protection planning is a legitimate concern for many of us. The techniques available range broadly from conservative and established approaches to “cutting edge” concepts. Some are more effective than others and an awareness of the status of particular methods, as well as the nature of potential claims, will be important for you and your advisor. Consider involving an attorney or other professional who specializes in asset protection planning where there are substantial assets and a potentially high exposure to liability.
[i] The discussion of asset protection within the scope of estate planning is addressed in a separate article.
George Chamberlin & Mentor RIA Consulting © 2003-2017