If we could predict the future, asset protection planning would be easy. All that would be necessary is to see the risk coming and take the correct action to avoid a loss.
Of course, we can’t predict the future and so it’s difficult to know whether to plan to protect ourselves from losses due to a lawsuit, divorce, bankruptcy, nursing homes, or any other number of threats.
One thing we can be certain of is that failing to have a plan in place unnecessarily exposes ones assets to risk. It usually takes years to save up a nest egg or to build a business, but it may take only a short period of time to lose it all due to an unexpected life event.
It is also important to remember that as your assets increase, you become a more attractive target for lawsuits. Plaintiffs’ attorneys are not interested in suing people with no assets and/or no insurance, because no matter the size of the judgment, they won’t be able to recover anything. On the other hand, an individual with significant assets is an attractive defendant, because they have “deep pockets” to reach into to pay any judgment or settlement.
Before you read on, remember this: there is no such thing as an impenetrable asset protection plan. At its core, what many people refer to as asset protection is essentially “risk management.” It is the identification of the risks that are the greatest threat to one’s assets and the implementation of a plan to minimize those risks. Below are a few examples of how one can minimize risk.
The fundamental purpose of insurance is to spread the risk of loss between a large group of people. Most of us have car insurance or health insurance because we are concerned about the potential for a large financial loss due to a car accident or serious illness.
As any insurance agent will tell you, not all policies are created equal. For example, that budget car insurance that you purchased may have very low limits on the maximum it will pay as the result of any single car accident or to any single individual injured by you as the result of an accident. Or perhaps your homeowner’s policy protects you in the event that your home accidentally burns down, but it only provides minimal coverage in the event that someone is seriously injured on your property.
Dollar-for-dollar, an umbrella insurance policy can be one of the most affordable ways to obtain additional protection beyond what is provided by your home and auto policies. Note that before an insurer will sell you an umbrella policy, however, they will require that you maximize the limits of your coverage under your home and auto policies. This means that even though the premium for the umbrella policy may be inexpensive compared to the amount of coverage it provides, you may have to start paying more premium on your other policies as well.
Life insurance is another product that can be a beneficial part of an overall asset protection strategy. For example, you obtain a policy on the life of your business partner to provide a source of funds to buy out your partner’s heirs for an agreed price in the event of your partner’s death. This can help prevent a scenario in which your partner’s surviving spouse owns half of your business, but you do not have sufficient cash to buy him or her out.
Long-Term Care Insurance is a good way to protect against what is perhaps the most likely risk many of us will face—the possibility that we will spend several months or several years in a nursing home or assisted living facility. As with life insurance, not all policies and not all insurers are created equal. If you have a policy which is more than ten years old, consider having someone review what benefits the policy provides and its cost. You may be surprised to learn that an older policy has not kept up with inflation, or that you may be able to obtain an equal or greater benefit for a lower premium.
Sometimes people don’t purchase long-term care insurance because they cannot afford or do not want to pay the premium for a policy with all of the bells and whistles. Consider, however that even a policy which pays only a portion of the daily cost of long-term care, when combined with your other sources of income late in life can significantly slow the rate at which you lose your assets.
It is rarely a good idea to operate a business without setting up an appropriate business entity. When the owner/operator of a business does not create an entity (such as a corporation, an L.L.C., or a P.C., to name a few) then the business is said to be a “sole proprietorship.”
If a sole proprietorship is sued, the business and its owner are one in the same. The liability created by the business must be borne by its owner. By creating an L.L.C. or corporation, however the owner of the business has created a legal entity that is separate and distinct from the owner. The result is that the owner is shielded from the liability of the corporation.
Businesses-owners need not operate their entire operation under a single business entity, however. For example, it is not uncommon for a business-person to set up one L.L.C. to operate their actual business, and second L.L.C. to own the real estate where the business is located. By dividing the real estate portion of the business from the operating portion, the business-owner may be able to limit the liability to the actual business operation in the event someone is injured due to a defect in the building, for example. Of course, this requires that the business entities be properly established and maintained as distinct entities according to applicable law.
A trust is essentially a contract between three parties: the Grantor, the Trustee, and one or more Beneficiaries. The Grantor (sometimes called the “settlor”) is the person who creates the trust. The Trustee is the person who manages the trust property according to the terms of the trust (as set out by the Grantor). Finally the Beneficiary (or beneficiaries) get the benefit of the trust.
Like contracts, trusts are very flexible and can be designed for a number of purposes, one of which is asset protection. Trusts that are either established the grantor’s lifetime (called a “living trust” or “inter vivos trust”) or upon the Grantor’s death, (called a “testamentary trust” because it is created by the Grantor’s last will and testament).
Living trusts and testamentary trusts may either be revocable or irrevocable. Revocable living trusts (“RLT”) are generally often used as asset-management tools and as will substitutes. They can allow the grantor (or grantors) to create a comprehensive plan to maintain control over their assets during his or her lifetime. In most cases, the grantor of a revocable living trust is also the trustee as well as the primary beneficiary.
Most RLT’s are designed so that while the grantor is living and of sound mind, he or she will maintain control over all of the trust assets. In the event that the grantor becomes mentally incompetent, the RLT can provide comprehensive instructions regarding who will take over management of the trust. If the trust is properly funded with the grantor’s assets, probate is avoided at the death of the grantor, avoiding the cost of delay of probating the grantor’s estate.
Revocable living trusts do not provide asset protection for the grantors during their lifetime, however. Many simple revocable living trusts are designed for the single purpose of avoiding probate. In order to achieve asset protection using a trust, an irrevocable trust is required.
Irrevocable trusts provide that the grantor must irrevocably give up the right to access property in the trust. In the event that the grantor is creating an irrevocable trust in order to minimize his or her estate for federal estate tax purposes, then the grantor must give up all access and control over the property funded into the trust. Because the federal estate tax exemption is very generous ($5.25 Million each in 2013), very few Alabamians are concerned about avoiding the federal estate tax.
For people who are not concerned with avoiding the federal estate tax, an irrevocable trust can be designed to provide asset protection to the grantor while permitting the grantor to indirectly exert control over the trust. Because the grantor cannot directly access any of the property in the trust for his or her own benefit, a creditor (for example, who obtained a money judgment against the grantor in a law suit) cannot reach assets in a properly drafted and funded irrevocable trust.
No discussion of asset protection planning is complete without some discussion of fraudulent conveyances. The fundamental principal behind the doctrine of fraudulent conveyances, is that you cannot transfer away your assets in order to protect them from being seized by a creditor to pay a debt.
For example, a plaintiff obtains a judgment against John Q. Public for $500,000 after John severely injured him in a car accident which was his fault. The day after the trial is over, John transfers all of his money in an irrevocable trust in order to avoid paying the judgment to the Plaintiff. John’s transfer of the property into the trust is a fraudulent conveyance to avoid the payment of a known, legitimate debt, and a court would order this transaction reversed.
Asset protection planning can only protect you from future, unknown debts, and not the other way around. Make sure you understand the consequences of any transfers you make as part of an asset protection plan.
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