August 26, 2010
Asset protection is achieved by arranging one’s assets to preserve maximum value for the owner and family, etc. in the event of creditor problems. It is not a single device that can be simply employed or elected. Instead, it involves the coordinated use of multiple legal disciplines, planning techniques and tools tailored to the assets and circumstances of the individual.
Asset protection planning begins with exercising care at the time debt is incurred or becoming involved in activities that pose financial risk. The provisions of loan documents should be carefully scrutinized to be sure that exposure in event of default is minimized. Risk arising from activities, rather than from loans, should be insured where possible.
Limited Statutory Protections
Although there are certain asset protections built into the law, these are very limited. Among the types of assets that are specifically protected by law are retirement benefits and equity in the family residence. Retirement benefits in plans qualified under the Internal Revenue Code are exempt from creditor claims in federal bankruptcy and state creditor proceedings. This suggests that debtors should consider maximizing the amounts in their IRAs and other qualified retirement plans. Equity in family residences is protected to different degrees under the homestead laws of the different states, so maximizing equity up to at least the amount of the homestead exemption should be considered by debtors.
Other than the statutory protections for certain assets and the protections of the bankruptcy laws, avoiding one’s legitimate creditors is not separately sanctioned under the law. Therefore, in order to be effective, asset protection should be undertaken in conjunction with, as a byproduct of and incorporated into other legitimate estate and business planning objectives and purposes. For this reason, asset protection is frequently embodied in one’s estate plan in the form of trusts, family limited partnerships and annuities.
Asset Protection Strategies
Although simply placing assets in a typical living trust usually provides no asset protection for the person who created the trust, it can be an asset protection trust for other beneficiaries of the trust by means of “spendthrift trust” provisions that are specifically sanctioned under most state laws.
Family limited partnerships are frequently used in estate planning for non-asset protection purposes, including making gifts to descendents in order to reduce one’s exposure to estate tax and involving junior generations in management. In appropriate circumstances and when properly structured, these partnerships can also provide a significant degree of protection of partnership assets from the creditors of partners.
Annuities provide a way to split ownership into the right revenue income retained by the donor and a remainder interest which is given away. The remainder interest is no longer subject to the donor’s creditors and under some state laws, all or a portion of the retained income interest may be exempt.
Offshore Asset Protection
Offshore trusts are sometimes established on the belief that the grantor-beneficiary’s interest can be better protected in a foreign jurisdiction than in a U.S. jurisdiction. This is done expecting that U.S. judgments are unenforceable in the foreign jurisdiction, which is almost universally not the case. One possible exception is the Cook Islands, but even that is unclear. Nonetheless, a foreign trust gives the grantor-beneficiary a degree of privacy and possibly the appearance of being judgment proof. Many other factors must be considered before establishing a foreign trust, such as the stability of the foreign country, the party holding the assets, and the laws of that jurisdiction regarding matters other than asset protection.
Regardless of the techniques to be employed, asset protection should be considered and implemented well before a financial crisis occurs in order to be effective - plan ahead.
This brief overview of some important considerations associated with asset protection is by no means comprehensive. Always seek the advice of a competent professional when making important financial and legal decisions.