An important gap in many financial plans is the failure to review with an estate planner the potential risks to losing assets and the ways available to protect those assets.
The risk to estate leakage from various risks can be reduced significantly.
You don’t need the elaborate and expensive strategies, such as multiple foreign trusts and corporations, that many people associate with asset protection.
In fact, courts are becoming less tolerant of many of those strategies.
Consider a strategy that is effective, affordable, and would trigger fraud alerts.
Four key principles underlie an effective asset protection strategy.
The plan needs to be flexible. You must be able to adjust it over time with changes in your goals, finances, and family, as well as the legal and economic environment.
Asset protection always is evolving. For example, in 2024 California reduced the protections from creditors of some retirement plan distributions.
A second principle is to use multiple strategies. Relying on one strategy or tool to protect most of your assets is very risky.
The third principle is the plan must be cost effective.
The fourth principle might the most important. Your plan must be implemented before there’s a problem. When you wait until there are active or looming risks, it’s too late.
Most courts will ignore asset protection moves taken after that point, labeling them as fraudulent conveyances. Attorneys often refuse to implement strategies in that situation, because it puts their law licenses and sometimes their liberty at risk.
The main goal of asset protection is to deter or cut short litigation by convincing the other side that collecting a judgment would be difficult. That gives them an incentive to settle for a reduced amount.
Some of the elaborate asset protection strategies emphasize secrecy. Those are the plans courts are most likely to ignore. Those plans also can encourage plaintiffs to search aggressively for all your assets and be confident a court will rule in their favor.
An asset protection plan needs a justification other than asset protection. When the sole intent appears to be asset protection, which is the case with the secret plans, courts are more likely to disallow the protection.
A good asset protection strategy is part of a solid wealth planning and estate planning process for transferring wealth to others.
The first step in any wealth protection plan is to have adequate insurance for both liabilities and damage to property. Supplement that coverage with a healthy personal umbrella liability insurance policy.
With your estate planner and insurance professional, review the liability levels in the insurance for your home, autos, boats, and any other property you own. Business owners and professionals should have separate liability insurance for those risks. They might also want insurance for cybersecurity and product liability.
Solid insurance coverage is essential to protecting your wealth. Insurers often pay for or have their attorneys handle your defense. Also, when there’s adequate liability coverage, many attorneys will encourage their clients to settle for what the insurance will pay.
The next steps are to determine how much of your wealth is in assets that are protected from creditors under state or federal law and consider converting more wealth into protected assets.
These often are called exempt assets, because they are exempt from creditors’ claims.
In many states, home equity at least up to a certain amount is exempt. Some states exempt unlimited or very high levels of home equity.
Retirement accounts often are exempt under federal and state law, including IRAs as well as 401(k)s and other employer-sponsored plans. Sometimes assets are exempt only while they are in the plan. At other times, distributions from the plans also are protected from creditors.
Life insurance and annuities usually are protected.
The list of protected assets and the details of the exemption are different from state to state, and protections under federal law probably don’t match your state law.
To maximize protected assets, you’ll want to work with an estate planner or asset protection specialist who knows your state law’s details. Some people move to another state to make more of their assets exempt.
Another step is to shift assets so they are owned by entities that protect them from creditors.
The rules here also vary considerably from state to state, but the irrevocable trust is the pre-eminent vehicle for protecting assets. A venerable strategy is to have assets owned by an entity, such as a limited liability company, partnership, or corporation. Then, transfer ownership of the entity to one or more irrevocable trusts.
It’s important that the trust be irrevocable, meaning you generally can’t change it. Assets you transfer to the trust no longer are legally your property and aren’t owned by your children or grandchildren. You can’t force the assets be returned. To maximize asset protection, the trustee should be an independent person or entity.
Your children or grandchildren or both, but not you, are the beneficiaries. You can set up one trust that benefits the group or separate trusts for each beneficiary or group of beneficiaries.
The children or grandchildren benefit from the trust’s wealth over time. Since your loved ones don’t own the assets outright, it should be safe from their creditors, potential ex-spouses, and others. It also is safe from their bad decisions about investments and spending.
To fully protect the assets, give the trustee discretion over the distributions.
The trust should allow what’s known as decanting. That’s when the trustee or a trust protector essentially closes the trust and moves the assets to a new trust. Each state has limits on decanting. The new trust must be irrevocable and have some other provisions matching the original trust.
Decanting can be a valuable tool when there’s a major change in the law or the beneficiary’s circumstances, or there’s dissatisfaction with the trustee.
You should work with your estate planner to carefully choose the state where the trust is located. A trust is located where the trustee resides.
Some states have laws that make them more attractive locations for trusts by allowing many of the protections available in foreign trusts but at lower cost and without triggering attention from the IRS. The most favorable states probably are South Dakota, Nevada, Alaska, and Delaware, but don’t rule out others.
A potential disadvantage is the state laws are fairly new and haven’t been tested in the courts. Also, the laws tend to have waiting periods. For example, all the asset protections might not kick in until the trust has owned the assets and been located in the state for at least four years.
If you choose a state other than the one where you are resident, a bank or trust company probably must be the trustee.
There are several other elements to consider for your asset protection plan.
You can make outright gifts to others when the primary goal is to protect assets from your potential creditors.
You also can consider transferring assets to a trust that benefits your spouse. The assets should be protected from your creditors, but you benefit from the trust indirectly when distributions are made for your spouse’s benefit.
You also can sell assets. For example, you can sell an asset to family members in exchange for either a long-term installment note or a private annuity. You benefit from the payments, but your creditors might not be able to attach the asset. Don’t attempt this without the help of good professional advisor.
One strategy used with a personal residence or other real estate is to encumber it with debt. The asset has little equity and so has little value to creditors. You receive the loan proceeds and structure them to be safe from creditors.
For most people, the best solution is a combination of strategies that varies with their goals, the assets they own, and whether their main concern is their creditors or what might happen with the next generation.
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