What is Asset Protection Anyway?
Asset protection planning is about protecting your assets in good times, so you can walk away with those assets if something goes wrong financially. The people who use asset protection plans most commonly are people likely to get sued, such as real estate developers and investors, physicians and business owners whose business involves liability or lawsuit risks. But even an average Joe or Jane can get caught up in a difficult situation, so if you have something to protect then asset protection should at least cross your mind.
Many people are concerned about having their assets taken from them by creditors. This is about planning for future claims not current ones. If there are already existing claims against you it is too late. There is no strategy that will protect you against an existing creditor at that point. If you attempt to move assets to avoid paying a claim, you risk being liable for a “fraudulent conveyance” and that is a big no-no. Not only can the transfer be undone, in most states, including Arizona, it can be a misdemeanor or felony crime! Clients ask lawyers about transferring assets after they learn about a claim all of the time. The correct and appropriate advice is that you should do your best to defend and settle the claim. If you are being told to hide your assets, run away.
There is a trade-off The challenge in estate planning is that you cannot always have your cake and eat it, too. The more asset protection you get, the more it will cost you and less flexibility you will have. So the first question is determining what level of asset protection you need for you and your assets.
Not everyone has creditors lurking at their doorstep, but the potential is always there. Figure out whether you might face such creditors at some point as a starting point.
What Asset Protection is Not
If you ask people what they think asset protection is, most will say it is a way to shield all of your assets from creditors or some “off-shore” thing. While shielding your assets is the goal, the actuality is that asset protection planning is a way to minimize the extent that assets are available to creditors or to discourage them from pursuing a claim. Look at it this way: if no asset protection is in place then 100% of your assets are available to the creditor. So, while asset protection may not be a total shield, any legitimate efforts made to reduce the extent of claims against you assets is a victory. Any settlement of a claim for less than the claim is really the goal of asset protection planning.
Basic Asset protection steps
1. Liability Insurance. This is the first line of defense. Not only should you have basic coverage you should obtain an “umbrella” policy on your homeowners policy. It is relatively inexpensive for the coverage and is well worth it.
2. Business Liability coverage. If you own a business this is a must. Discuss with your agent what types of coverage you need for the risks involved in running your business. Even if a claim is made that has no merit, most policies will cover the cost of defense which is a huge benefit if you are sued.
3. Take advantage of the Homestead Exemption for your home. If you have cash (I know, not everyone does…) use it to make improvements on your home or to pay down the mortgage to the level of your homestead exemption.
4. Retirement Plans. If covered by Federal law and under some states laws, these accounts are exempt from creditors.
5. Life Insurance. Many states, including Arizona, have exemptions that protect life insurance and annuities from creditors.
Business Asset Protection
1. Create an LLC or other entity. Stop running your business as a sole proprietor because that puts all of your assets at risk, both business and personal.
2. Divide your business into multiple entities. It may be possible to split up your business into separate entities and protect them from claims against the other. For example, you might consider holding real estate in one entity and the operations of the business in another.
3. Caution: Using a business entity does not provide protection against personal guarantees or your own negligence or intentional misconduct. Also the protection of the entity is usually from a “charging order.” That is like a lien against the income and assets that cannot be used until there is a distribution. So, while your creditor cannot get the income or a distribution – neither can you.
More Complex Strategies
If you are in a profession or business where the exposure to risk is higher, then you may need to explore more complex asset protection strategies. The cost of developing and implementing these strategies is much higher and involve giving up some level of access or control of your assets. The theory of asset protection at this level is if you do not have access, then neither do your creditors. It is all about moving assets as far from you as is feasible.
1. Create Irrevocable Trusts for family members. As long as the transfer or gift to an irrevocable trust cannot be considered a fraudulent conveyance, this puts assets out of your hands although it may be subject to the claims against the beneficiary’s interests.
2. Keep all or some of the benefits of an irrevocable trust. If you transfer all of your interest in an asset to an irrevocable trust, it is not available to the creditors. There are other trusts that allow you to keep some interest in such a trust. Examples include a “qualified personal residence trust” (“QPRT”), charitable remainder trust (“CRT”), and a grantor-retained annuity trust (“GRAT”) or a Special Power of Appointment Trust (“SPAT”).
3 Domestic Asset Protection Trust. This type of trust is created for your own benefit. A handful of states allow protection even when the person who forms the trust is a beneficiary. The most common used states are Nevada and Delaware. Specific rules apply to these trusts. The law on these trusts for non-residents is still unsettled so creating carries the risk they just may not work. While most legal advisors believe there is good reason to believe the courts will honor these trusts, constitutional issues are implicated particularly when the person who creates the trust is not a residence of the state where the trust is formed. Again, the mere fact that such a trust is created may be enough to discourage all but the biggest and well-funded creditors.
4. Marital Agreements. If one spouse is in a profession or business that carries a high risk of liability, one option is to divide the assets between the spouses. The business assets to one spouse and the investment assets to the other. This has implications in community property states and creates potential divorce and income tax basis issues.
5. Foreign Trusts. If you are reading this blog, this probably is not a viable or reasonable option for you.
For most people, the basic steps of asset protection should be sufficient. If your level of risk is higher because of your business or profession, using a combination of trusts and business entities provides more protection. These steps require a detailed analysis of your particular situation and advice from your legal advisor.
For more information about Poulos Law Firm asset protection planning contact:
Gregory C. Poulos
Poulos Law Firm, PLLC