Protecting Your Assets
If you don't properly protect your assets, which you worked long and hard to accumulate, they can be lost very quickly in a lawsuit, in bankruptcy or if creditors come to collect. Lawmakers have passed legislation under which certain types of assets are, or can be, shielded, and in this article, we discuss those laws and what measures you personally can take to protect your savings.
Anyone With Assets Needs Protection from Lawsuits
You may think doctors, corporate executives and those in other litigation-prone professions are the only ones who need to worry about protecting their assets. Not so. There are many circumstances under which your assets can be attached or garnished. These include if your file for bankruptcy, you get a divorce or you are on the defensive end of a civil lawsuit. Most people don't even consider these circumstances until they occur. For instance, if your teenage child is on the wrongful end of a motor vehicle accident, it could result in the damaged party going after your assets.
Picture this scenario: You hear a knock at the door one night. You find an elderly couple looking for the Jones. Your name is Carpenter. The Jones' live next door, you inform the couple. The couple thanks you and walks across your lawn to go to the Jones'. When they get halfway across, the man steps into a hole your dog dug that afternoon and breaks his hip – the one he just had replaced. The next call you get may be from a lawyer trying to find out your financial worth and what type of insurance you carry.
It doesn't matter that the couple should have stayed on the sidewalk or at least taken care to ensure they avoided such an accident. In the end, your home + your dog + your hole = your fault.
Laws May Protect Some of Your Assets
Federal and state laws determine what type of protection, if any, your assets have from creditors and lawsuits.
Protection Caps for Traditional and Roth IRAs
Contributions and earnings in your traditional and Roth IRAs have an inflation-adjusted protection cap of $1 million against bankruptcy proceedings. The bankruptcy court has the discretion to increase this cap in the interest of justice.
In addition, amounts rolled over from qualified plans, 403(b)plans and 457(b) plans have unlimited protection. However, this protection only applies to bankruptcy, not to judgments awarded in other courts. In such cases, state law must be consulted to determine whether any protection exists and to what degree. (For related reading, see: Can creditors garnish my IRA?)
Qualified Retirement Plans
Employer-sponsored plan assets have unlimited protection from bankruptcy, regardless of whether or not the plan is subject to the Employee Retirement Income Security Act (ERISA). This includes SEP IRAs, SIMPLE IRAs, defined-benefit, defined-contribution, 403(b), 457, and governmental or church plans under code section 414. (Note: Amounts in your SEP IRA that are attributable to regular IRA contributions are subject to the $1 million cap.)
ERISA plans are also protected in all other cases, except under a qualified domestic relations orders (QDROs), where assets can be awarded to your former spouse or other alternate payees, and tax levies from the IRS. For this purpose, a qualified plan is not considered an ERISA plan if it covers only the business owner. Protection for owner-only plans is determined by state law.
Homesteads
The amount of protection you have for your home varies widely from state to state. Some states offer unlimited protection, others offer limited protection and a few provide no protection at all.
Annuities and Life Insurance
Like the protection of homesteads, state laws determine the level of protection applied to annuities and life insurance. Some protect the cash surrender values of life insurance policies and the proceeds of annuity contracts from attachment, garnishment or legal process in favor of creditors. Others only protect the beneficiary's interest to the extent reasonably necessary for support. There are also states that do not provide any protection. To find your state's asset protection laws, visit your state's official website.
Steps You Can Take to Keep Your Assets Safe
Although asset protection may have had a tainted past, legitimate strategies are available. Putting up as many obstacles as possible for potential creditors to jump over before they can get to your property might encourage them to make favorable settlements instead of getting involved in long and expensive litigation.
Common methods for asset protection include:
Asset Protection Trusts
For years, wealthy individuals have used offshore trusts in locations like the Cook Islands and Nevis to protect assets from creditors. But these trusts can be expensive to establish and maintain. Now several states, including Alaska, Delaware, Rhode Island, Nevada, South Dakota and more, allow asset protection trusts, and you don't even have to be a resident of the state to buy into one.
Asset protection trusts offer a way to transfer a portion of your assets into a trust run by an independent trustee. The trust's assets will be out of the reach of most creditors, and you can receive occasional distributions. These trusts may even allow you to shield the assets for your children.
The requirements for an asset protection trust are:
- The trustee be an individual located in the state or a bank or trust company licensed in that state.
- It must only allow distributions at the trustee's discretion.
- It must have a spendthrift clause.
- Some or all of the trust's assets must be located in the trust's state.
- The trust's documents and administration must be in the state.
If you are considering an asset protection trust, be sure to work with an attorney who is experienced in this field. Many individuals have run afoul of tax laws because their trusts did not satisfy regulatory requirements.
Accounts-Receivable Financing
If you own a business, you could borrow against its receivables and put the money into a non-business account. This would make the debt-encumbered asset less attractive to your creditors, and make otherwise accessible assets unreachable.
Strip out Your Equity
One option for protecting your assets is to pull the equity out of them and put that cash into assets your state protects. For example, suppose you own an apartment building and are concerned about potential lawsuits. If you took out a loan against the building's equity, you could place the funds in a protected asset, such as an annuity (if annuities are sheltered from judgments in your state).
Family Limited Partnerships
Assets transferred into a family limited partnership (FLP) are exchanged for shares in the partnership. Because the FLP owns the assets, they are protected from creditors under the Uniform Limited Partnership Act. However, you control the FLP and, thus, the assets. There is no market for the shares you receive, so their value is significantly less than the value of the asset exchanged.
Less Complex Ways to Protect Assets
There are some inexpensive, simple ways to protect assets that anyone can implement:
- Transfer assets to your spouse's name. However, if you divorce, the end results could be different from what you intended.
- Put more money into your employer-sponsored retirement plan because it might have unlimited protection.
- Buy an umbrella policy that protects you from personal-injury claims above the standard coverage offered in your home and auto policies.
- Make the most of your state's laws regarding homesteads, annuities and life insurance. For instance, paying down your mortgage could protect cash that is otherwise vulnerable.
- Don't mix business assets with personal assets. That way, if your company runs into a problem, your personal assets may not be at risk and vice versa.
Some Final Words of Caution
You may have seen self-proclaimed asset-protection experts advertise their seminars or easy-to-use kits on TV or the internet. Perform extensive research, including checking with the Better Business Bureau before deciding to use any of these services.
And before you take any of the steps discussed in this article, meet with an attorney who is familiar with the laws of your state and an expert in the asset protection field. Most importantly, don't wait until you have a judgment against you. By then it may be too late, and the courts could declare that you made a "fraudulent transfer" to get out of meeting your obligations.