If you don't properly protect your assets, which you worked long and hard to accumulate, they can be lost very quickly in a lawsuit or bankruptcy or if creditors come to collect. It's important to be aware of the laws that can shield certain types of assets and the measures you can take to protect your savings.
- Medical professionals and corporate executives aren’t the only ones who may be subject to lawsuits and need to protect their hard-earned assets.
- Various investment accounts, such as individual retirement accounts (IRAs), carry a certain amount of protection in the interest of justice.
- Federal laws protect numerous retirement plans, but many states also offer asset protection trusts that safeguard homesteads, annuities, and life insurance.
Why You Need Protection from Lawsuits
You may think doctors, corporate executives, and those in other litigation-prone professions are the only ones who need to worry about protecting their assets. Not so. There are many circumstances in which your assets can be attached or garnished, including if you file for bankruptcy, get a divorce, or are on the losing side of a civil lawsuit.
Most people don't consider these circumstances until they occur. If your teenage child is on the wrongful end of a motor vehicle accident, for instance, it could result in the damaged party going after your assets.
Picture this scenario: You hear a knock at the door one night. You find an elderly couple looking for the Smiths. Your name is Jones. You inform the couple that the Smiths live next door. The couple thanks you and walks across your lawn to go to the Smiths. When they get halfway across, the man steps into a hole that your dog dug and breaks his hip—the one he just had replaced. The next call you get could be from a lawyer trying to find out your financial worth and what type of insurance you carry.
It doesn't matter that the couple should have stayed on the sidewalk or at least taken care to avoid such an accident. In the end, your home, your dog, and a hole in your yard makes it your fault.
Protection Caps for IRAs
Contributions and earnings in your traditional and Roth individual retirement accounts (IRAs) have an inflation-adjusted protection cap of $1 million against bankruptcy proceedings. The bankruptcy court has the discretion to increase this cap in the interest of justice.
In addition, amounts rolled over from qualified plans, such as 403(b) and 457 plans, have unlimited protection. However, this protection only applies to bankruptcy, not to judgments awarded in other courts. In such cases, state law must be consulted to determine whether any protection exists and to what degree.
Many U.S. laws protect assets in the event of lawsuits, bankruptcies, and collection agency actions. Purchasing asset protection is often cheaper than leaving yourself exposed to the worst-case scenario.
Qualified Retirement Plans
Assets in employer-sponsored plans have unlimited protection from bankruptcy, regardless of whether or not the plan is subject to the Employee Retirement Income Security Act (ERISA). This includes SEP IRAs, SIMPLE IRAs, defined-benefit and defined-contribution plans, 403(b) and 457 plans, and governmental or church plans under the Internal Revenue Service (IRS) code section 414. Amounts in your SEP IRA from regular IRA contributions are subject to a $1 million limitation.
ERISA plans are also protected in all other cases, except under qualified domestic relations orders (QDRO)—where assets can be awarded to your former spouse or other alternate payees—and tax levies from the IRS. For this purpose, a qualified plan is not considered an ERISA plan if it covers only the business owner. The protection for owner-only plans is determined by state law.
The amount of protection you have for your home varies widely from state to state. Some states offer unlimited protection, others offer limited protection, and a few states provide no protection at all. Be sure you know what your state's protections are.
Annuities and Life Insurance
Like the protection of homesteads, the level of protection applied to annuities and life insurance is determined by state law. Some protect the cash surrender values of life insurance policies and the proceeds of annuity contracts from attachment, garnishment, or legal process in favor of creditors. Others protect only the beneficiary's interest to the extent reasonably necessary for support. There are also states that do not provide any protection.
How to Keep Your Assets Safe
Although asset protection may have had a tainted past, legitimate strategies are available. Creating as many obstacles as possible for potential creditors to pass before they can get to your property could encourage them to make favorable settlements instead of getting involved in long and expensive litigation.
Asset protection trusts
For years, wealthy individuals have used offshore trusts in locations like the Cook Islands and Nevis to protect assets from creditors. But these trusts can be expensive to establish and maintain. Now a number of states, including Alaska, Delaware, Rhode Island, Nevada, and South Dakota, allow asset protection trusts (APT), and you don't even need to be a resident of the state to buy into one.
Asset protection trusts offer a way to transfer a portion of your assets into a trust run by an independent trustee. The trust's assets will be out of the reach of most creditors, and you can receive occasional distributions. These trusts may even allow you to shield the assets for your children.
The requirements for an asset protection trust are:
- It must be irrevocable.
- The trustee must be an individual located in the state, or a bank or trust company licensed in that state.
- It must only allow distributions at the trustee's discretion.
- It must have a spendthrift clause.
- Some or all of the trust's assets must be located in the trust's state.
- The trust's documents and administration must be in the state.
If you are considering an APT, be sure to work with an attorney who is experienced in this field. Many individuals have run afoul of tax laws because their trusts did not satisfy regulatory requirements.
If you own a business, you could borrow against its receivables and put the money into a non-business account. This would make the debt-encumbered asset less attractive to your creditors, and make otherwise accessible assets unreachable.
One option for protecting your assets is to pull the equity out of them and put that cash into assets that your state protects. Suppose, for example, that you own an apartment building and are concerned about potential lawsuits. If you took out a loan against the building's equity, you could place the funds in a protected asset, such as an annuity (if annuities are sheltered from judgments in your state).
Family limited partnerships
Assets transferred into a family limited partnership (FLP) are exchanged for shares in the partnership. Because the FLP owns the assets, they are protected from creditors under the Uniform Limited Partnership Act (UPA). However, you control the FLP and thus the assets. There is no market for the shares you receive, so their value is significantly less than the value of the asset exchanged.
Other Ways to Protect Your Assets
There are some inexpensive, simple ways to protect assets that anyone can implement:
- Transfer assets to your spouse's name. However, if you divorce, the end results could be different from what you intended.
- Put more money into your employer-sponsored retirement plan because it might have unlimited protection.
- Buy an umbrella insurance policy that protects you from personal injury claims above the standard coverage offered by your home and auto policies.
- Make the most of your state's laws regarding homesteads, annuities, and life insurance. Paying down your mortgage, for example, could protect cash that is otherwise vulnerable.
- Don't mix business assets with personal assets. That way, if your company runs into a problem, your personal assets may not be at risk and vice versa.
The Bottom Line
You may have seen self-proclaimed asset-protection experts advertise their seminars or easy-to-use kits on TV or the internet. Perform extensive research, including checking with the Better Business Bureau (BBB) before deciding to use any of these services.
And before you take any of the steps discussed in this article, meet with an attorney who is familiar with the laws of your state and is an expert in the asset protection field. Most important, don't wait until there is a judgment against you. By then it may be too late, and the courts could declare that you made a "fraudulent transfer" to get out of meeting your obligations.