Protecting your assets against lawsuits, divorce, tax liens, and bankruptcy is a must-do for your financial security. If you neglect this key piece in building your wealth, you could lose everything. Simple aging, for example, is making more of you vulnerable to high medical bills, triggering bankruptcy in many cases. During that process your primary residence could be taken away. Because your credit rating is destroyed, no one will rent to you.
The good news is that you can prevent those kinds of grim scenarios. It is possible and highly probable that you could emerge from a personal/business bankruptcy, litigation, end of a marriage, or negotiations with a vicious judgment creditor and end up financially comfortable. To achieve that kind of financial “happy ending,” you will have to follow proven strategies for asset protection and avoid the ones which could do you harm.
Avoid being perceived as a “deep pocket,” both in everyday life and on paper. America is the land of legal actions. Among its 300 million+ residents, there are about one million lawyers.
Lawyers target those with accumulated wealth. The joke is: How many homeless people or starving actors in Manhattan have been sued? Being perceived as a “deep pocket” could result from an expensive lifestyle or having a large mortgage paid off.
It is common financial sense to make wealth less visible by leveraging the most appropriate asset protection tactics. They could range from establishing an irrevocable trust to maintaining several kinds of retirement accounts. On the other hand, a paid-off mortgage creates the equity worth going after in litigation. Also, the funds you used for paying it off could have been invested and yielded a return higher than the mortgage interest rate.
Take action now. Once you sense you might need to shield your assets, it will be too late. The legal system will interpret your activities to conceal assets as “fraudulent transfer.” Given digital technology, it is easy to track the details of those financial transactions.
It is sound financial prudence to assume that you personally and/or your business will bump up against a legal action. You son, who is driving your car, could be judged to have caused a fatal accident. Your home improvement franchise is sued for alleged personal injury to another.
First you must know how to protect your assets. Then you must take action now. The situation is urgent.
Own more than enough insurance – but it’s not enough. Insurance is a sophisticated multi-purpose financial tool. And it is your first line of defense in protecting your assets. Other asset protection strategies, it has been said, are supplemental to this one. We agree. The problem is that there are too many exceptions written into today’s insurance policies. Just when you need it, they point to page seven line 14 in your policy as to a reason why they will not pay the claim.
In most states, whole life insurance or the cash-value account is shielded from lawsuits. At the same time its rate of return is higher than that of banks.
Annuities, which sometimes take the form of insurance, are also shielded in many states from lenders and plaintiffs.
Insurance can reduce the amount of a judgment which will come from your pocket.
It can pay legal expenses in some cases.
It can preserve your nest egg from medical and nursing-home bills.
But insurance is a complex financial instrument. That means you have to spend the time learning what the types of insurance and what each particular policy covers.
Some, such as umbrella insurance, are surprisingly affordable. Umbrella coverage covers the gaps in what your other policies, such as auto or home, don’t. For instance, the plaintiff in an accident settles for $3 million. The limit on your auto insurance is $500,000. Your umbrella policy covers up to $5 million.
Keep personal and business financials separate. At the very least, financial transactions should not be commingled. That in itself opens the door to plaintiffs assessing damages based on both personal and business assets. Yes, have separate credit cards and separate bank accounts.
There are business structuring tools such as the limited liability company (LLC) which shield personal assets. On the other hand, trusts could be the right financial vehicle to protect personal assets.
Understand your own state’s laws. States rights or the ability for each state to govern its residents according to its own laws are guaranteed in the U.S. Constitution. Therefore, you must review the specific laws in your state about financial matters. This is very serious.
For example, only a few states allow for protection of all of your home equity from creditors (homestead exemptions). Also, only a number of states provide titling of the primary residence as “tenants by the entirely.” Since the property is owned jointly by both parties, it cannot be sold by the one being pressured for payment. That tactic is a useful alternative when there is a not a homestead exemption. In itself, it can deter legal action if the home is the only significant asset.
In addition, there is the assumption that all retirement accounts are bulletproof asset protection vehicles. The reality is different. According to federal law – the 2005 Bankruptcy Reform Act – in bankruptcy there is unlimited protection for ERISA-qualified retirement plans and up to $1 million for IRAs. However, some states have opted out of the federal bankruptcy exemptions. Others have lowered the exempt amount. Many states allow the seizure of your IRA in certain instances.
Do due diligence on each and every shielding tactic. The growing need for asset protection has generated a proliferation of information simplified for the layperson. Unfortunately, asset protection is hardly simple.
Steps in the process cannot be boiled down to one-liners such as “Maximize the funds you put in retirement accounts.” The reality is that each of you has a unique financial situation. Your business might require heavy cash flow, especially in the off-season. Therefore, having so much in retirement accounts with penalties for early withdrawal does not make financial sense. You have to do your “due diligence” on what are the most appropriate retirement accounts and how much to fund them with.
Another misleading recommendation is “Put your money in an offshore trust.” With so much government scrutiny of trusts in locations such as the Cayman Islands, that option has become expensive and restrictive. Some states such as Alaska currently provide that kind of service. Both offshore and U.S. based trusts require you to do your homework about the types available and the benefit/cost.
There are also five must-not-dos when it comes to asset protection.
Don’t panic if you sense your unprotected assets will be taken. Once you are in that position, your financial records and transactions are already being monitored. Should it be discovered that you tried to conceal assets, that could be defined as “fraudulent transfer.” A fraudulent transfer is merely a civil matter and does not generally have any criminal consequences. So, you can still protect your assets but the courts would be much happier with you if you protected yourself well beforehand.
In addition to safeguarding your assets, an additional option is to put up a fight. Many “debtors” just comply. The forms your push-back could take are diverse. Those include refusing to settle and going to trial, appealing the verdict, negotiating a lower amount, working out an affordable payment schedule, and bringing your situation to the court of public opinion.
Don’t just stick with one or two tactics. The same principle which applies to building wealth pertains to protecting it. That’s diversification. Because you live in a state with the homestead exemption, don’t assume your home is safe. It is protected unless you file for bankruptcy within a certain period of time after buying your home. So, you pay off the mortgage early, put funds into an IRA or whole life insurance policy, and have a small business structured as an LLC. If one of them doesn’t work out, such when the real estate market crashes, you are left with a devalued asset, but the other assets may be intact. So make sure to diversify your assets into various legal tools and strategies.
Don’t take financial shortcuts. To avoid the complexities of asset protection you might be tempted to transfer money to minor children. That’s easy, right? One of the myriad problems is that when your children reach the age of majority you lose control of that asset. Another shortcut is transferring funds to your spouse. If you divorce, that will be huge a regret.
Instead, you can be creative. You own investment real estate and are concerned about the litigation which is always possible. One option to protect that asset is to take a loan on its equity. Then put the loan funds into a protective structure such as an offshore asset protection trust.
Don’t assume you will be the exception to the rule in professions which are vulnerable to lawsuits. Medical doctors, architects, psychotherapists, and lawyers are among the professionals who are litigation targets. Yet, if you are, for example, an MD, you might assume you can avoid being sued by, for example, practicing defensive medicine and/or providing a great bedside manner. Therefore, you don’t maximize your use of asset reduction tactics. However, you get sued anyway, and your malpractice insurance doesn’t pay for all the damages, you lose the primary home, getaway, car, and boat.
Don’t assume your situation is “set.” Asset protection is a work in progress. Federal laws change. State laws change. Your spouse develops dementia. The neighborhood in which you bought the fixer-upper becomes gentrified. Your child is entering college. At age 57, you lose your job and can’t find a comparable one. As these setbacks develop, you have to be assessing the appropriateness and benefit/cost of your asset protection tactics.
Those new to asset protection may feel overwhelmed by the complexity of the subject matter. In addition, as with all financial matters, there are so many options within the strategies. To both protect the asset and increase wealth you can do X or Y or Z. However, with time, among the rewards is the sense of mastery over shaping your financial future.
For those who have already taken steps in protecting assets, you may be motivated to re-assess your tactics. At the same time you may discover ways to boost your return on investment.
In essence, asset protection can be your individual platform for unique kinds of learning – and earning.
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Jane Genova, Legal Communications, Harvard Law School