Five Tools for Protecting Your Assets in Estate Planning
With a solid financial plan in place, you have a good grasp on your net worth and future accumulation of wealth. Next, it’s time to start thinking about asset protection as you kick off the estate planning process.
By definition, asset protection is designed to keep your wealth and property safe from future potential creditors (e.g., someone who wins a lawsuit against you). Whether your concern lies with personal or business assets, there are various tools designed to keep your property safe from tax collectors, accident victims, healthcare providers, credit card issuers, business creditors, and creditors of others.
To insulate your property from potential claims, you must evaluate each tool based on your unique situation. You may decide that insurance and a declaration of homestead provide sufficient protection for your home because your exposure to a claim is low. For more highly exposed individuals, you may need to create a business entity or an offshore trust to shield your assets.
It’s important to remember that no asset protection tool is guaranteed to work, and you may need to adjust your asset protection strategies as your situation and the legal landscape evolves. Following are some asset protection tools for your consideration:
1. Liability Insurance
Liability insurance is your first and best line of defense and should serve at the top of any asset protection plan. You should consider purchasing or increasing umbrella coverage on your homeowners policy. For businessrelated liability, you can just as easily purchase or increase your liability coverage under your business insurance policy. Generally, the cost of premiums for this type of coverage is minimal compared to what you may be required to pay under a court judgment should you ever be sued.
2. Declaration of Homestead
A declaration of homestead over your primary family residence can protect what’s likely your most significant asset. State law determines the creditor and judgment protection afforded a residence by way of a declaration of homestead, which varies greatly from state to state. For example, a state may provide a complete exemption for a residence (i.e., its entire value), a limited exemption (e.g., up to $100,000) or an exemption under certain circumstances (e.g., a judgment from medical bills). A declaration of homestead is easy to file. You pay a nominal fee, complete a simple form, and file it at the registry office where your deed is recorded.
3. Asset Division Between Spouses
Perhaps you work in an occupation or business that exposes you to greater potential liability than your spouse’s job does. If so, it may be wise to divide assets between the two of you so that you keep only the income and assets from your job, while your spouse takes sole ownership of your investments and other valuable assets. Generally, your creditors can reach only the assets held in your name.
4. Business Entities
Business entities can provide two types of protection – shielding your personal assets from business creditors and shielding business assets from personal creditors. Using a corporation, limited partnership or limited liability company (LLC) to operate your business can help. Such business entities shield the personal assets of shareholders, limited partners or LLC members from liability that may arise from the business. The liability of these owners will be limited to only the assets of the business.
Conversely, corporations, limited partnerships, and LLCs provide some protection from the personal creditors of a shareholder, limited partner or member. In a corporation, a creditor of an individual owner is able to place a lien on, and eventually acquire, the shares of the debtor/ shareholder, but would not have any rights greater than the rights conferred by the shares. In limited partnerships or LLCs, under most state laws, a creditor of a partner or member is entitled to obtain only a charging order with respect to the partner or member’s interest. The charging order gives the creditor the right to receive any distributions with respect to the interest. In all respects, the creditor is treated as a mere assignee and is not entitled to exercise any voting rights or other rights that the partner or member possessed.
Certain trusts can preserve trust assets from claims. The key to using a trust as an asset protection tool is that the trust must be irrevocable and become the owner of your property. Once given away, these assets are no longer yours and are not available to satisfy claims against you. To properly establish an asset protection trust, you must not keep any interest in the trust assets or control over the trust.
Trusts can also protect assets from potential creditors of the beneficiaries of the trust. The extent to which a beneficiary’s creditors can reach trust property depends on how much access the beneficiary has to the trust property. The more access the beneficiary has to the trust property, the more access the beneficiary’s creditors will have – making the terms of the trust critical.
There are several types of asset protection trusts, each having its own benefits and drawbacks. These include:
- Spendthrift trusts
- Support trusts
- Discretionary trusts
- Personal trusts
- Self-settled trusts
Since certain claims can pierce domestic protective trusts (e.g., claims by a spouse or child for support, and state or federal claims), you can bolster your protection by placing the trust in a foreign jurisdiction. Offshore or foreign trusts are established under, or made subject to, the laws of another country (such as the Bahamas, the Cayman Islands, Bermuda, Belize, Jersey, Liechtenstein, and the Cook Islands) that generally does not honor judgments made in the United States.
Asset protection planning is a crucial part of protecting your wealth. Timing should be considered above all else. Courts will ignore transfers to an asset protection trust if:
- A creditor’s claim arose before you made the transfer
- You made the transfer with the intent to defraud a creditor
- You incurred debts without a reasonable expectation of paying them
Asset protection planning is a long-term exercise, not something that can be done as a quick or temporary fix. Avoid potential pitfalls by working to develop a proactive plan with an experienced professional.