After a lifetime of careful stewardship, diligent planning and hard work, many affluent individuals begin to look at how to transfer the assets they have accumulated in the most efficient manner, both for tax purposes and family governance. However, protecting those assets for the long term is all too often overlooked, or considered at most as an afterthought. In this article and the series to follow, we’ll explore various asset protection concepts and strategies, from rudimentary to complex.
But first, a few points of clarification…
Asset protection is not:
- Preventing lawsuits or hiding assets from the government or courts
- Taxation avoidance or illegal tax evasion
Preservation and protection of wealth done in advance, in an “above board” fashion for legitimate
business or estate planning purposes, including:
- Organizing assets and affairs in advance to minimize risk
- Legal strategies to contain risk and divide ownership structure to reduce exposure
- Designs discouraging litigation and encouraging settlement
- Good estate planning – used with insurance, not to replace it
What types of risk can potentially be mitigated?
All manner of risks can be incorporated into proper planning, from divorce (“bloodline protection,” such as of a child/beneficiary) and malpractice lawsuits, to substance abuse of heirs, cyber threats and a personal lack of legal capacity (i.e., Alzheimer’s disease). The first key to approaching each of these (and other) risks is to plan in advance. Creditors have rights too, and any planning done once an incident has occurred can and will be easily set aside as a fraudulent transfer (“fraudulent conveyance” in legal terms).
The first place individuals typically look is to gift assets potentially subject to creditor claims to heirs or beneficiaries. While this may potentially shield the assets from the initial owner’s creditors, it leaves the assets vulnerable to creditors of the beneficiaries, such as divorcing spouses, bankruptcy or vices. In this situation, proper trust and titling planning can be more effective.
Several states* offer a form of titling for spouses called “tenancy by the entirety,” whereby assets can only be accessible to creditors of both spouses, precluding access by creditors of only one spouse. Converting jointly held property to tenancy by the entirety can be an effective solution if one spouse has significant exposure to claims. Be aware, however, that such a titling may have unintended transfer ramifications.
Under ERISA, the federal law that governs qualified retirement plans, qualified retirement plans [401(k)s, Pension Plans, 403(b)s, 457(b)s] are afforded very strong creditor protections, provided they have more than one participant. IRAs have similar protections but are mandated on a state-by-state basis. Many states have unlimited protection for IRAs, or at least up to $1 million. Note that inherited IRAs are not typically afforded the same protections.
As a planning strategy, maximizing contributions to such plans is an excellent way to shelter assets from potential future creditors.
In most states, the death benefit of a life insurance policy is protected from creditors, and some states (such as Texas) offer generous creditor protections for cash values. This presents a planning opportunity whereby funds can be held within the cash value of a permanent life insurance policy, then be withdrawn as loans against the policy (such as in a Life Insurance Retirement Plan, aka a LIRP), thereby protecting the funds from creditors while remaining accessible to the individual.
Insurance can offer a distinct advantage over qualified plans in that there are not typically contribution limits for policies such as LIRPS, potentially allowing individuals to shelter over $1 million per year, versus annual contributions to qualified plans of less than $50,000.
Bear in mind many things can be insured beyond just one’s life. Many celebrities insure various features (Bruce Springsteen’s voice – $6 million, David Beckham’s legs – $70MM, Mariah Carey’s legs – $1 billion). While these examples don’t offer the ability to withdraw funds as a loan, they are excellent examples of how risk can be diversified away from oneself.
In the next installment of the series, we’ll address property agreements (pre- and post-nuptials) and limited partnerships/LLCs.
About the Author
Nathan J. Duncan, CFP®, AEP®
Nathan is the financial planning strategist for BB&T Wealth’s Texas and Ohio markets. He graduated from Miami University and Xavier University, and holds the CERTIFIED FINANCIAL PLANNER™ and Accredited Estate Planner designations.