Here today. Gone tomorrow. While the risk of losing substantial assets because of a creditor judgment is remote, it is worth thinking about, along with what you should be doing to prevent it. As wealth managers, we help clients diversifying their investment portfolios to preserve and grow their wealth with the appropriate amount of risk. Beyond investment risk management, clients should also focus on minimizing the risk of loss of their assets to creditors. Those creditors include tort judgments from a lawsuit (malpractice, auto accident, slip and fall on property, etc.), contractual obligations, divorce, or civil and regulatory penalties. This area of planning is generally referred to as Asset Protection.
Two big caveats up front:
- Asset protection planning is mostly governed by statutes and the case law of your state. What may work in one state, may not work in another. It is very important to consult an attorney in your state for the specific rules.
- If you have a creditor “knocking on your front door,” that is, a liability suit is within sight, it is generally too late to plan. Courts routinely set aside transfers under the Fraudulent Transfer Doctrine if you seek to make yourself “judgment proof” in the face of current or foreseen creditors.
Asset Protection 101
Once you’ve worked hard to accumulate significant assets, there are steps you can take to protect it. Following are some of the most important protective steps we encourage clients to take:
This is the simplest and easiest to do. You can pay a nominal amount to shift your risk of loss to an insurance company. In addition to basic auto and homeowner’s policies, clients should have an excess or umbrella liability policy that picks up where basic liability coverage leaves off. The amount of coverage will depend on your net worth. Most insurance providers will offer umbrella coverage as part of the other coverage you purchase for your auto and home. At Wealthspire Advisors, clients are able to obtain group coverage at competitive rates provided through an unaffiliated third party insurance provider.
2. Ownership of property
How you own and title your property is important. For example, in many states, property owned with your spouse as tenants by the entirety, is not subject to claims of creditors of one spouse. It is possible for a physician to own property with her husband by tenants by the entirety, rather than solely in her name. That way, if malpractice claims are made against her, the creditor may not attach this property to satisfy a judgment.
Ownership of certain property by an entity, rather than in personal name, can also afford protection to your personal assets. For example, owning a rental property in your name makes you personally liable on claims relating to that property such as a slip and fall on the property that exceeds your liability insurance coverage. However, if you own that property in an LLC, your personal assets would be protected from any judgments arising from your ownership of the property. It is important to note that you should respect the formalities of operating as a separate entity such as an LLC (separate checkbook, filing tax returns etc.), or it may not provide the protection you want.
Self-settled trusts that you establish for yourself are generally disregarded if a creditor seeks to attach the assets you put into this trust. However, several states have passed statutes that specifically allow some self-settled or asset protection trusts to be protected from creditors. There are off-shore versions of these as well. These trusts are complicated and require careful drafting and administration. While there is some disagreement around whether these trusts would survive a legal challenge, most practitioners agree that these trusts will at the very least put up a formidable roadblock against creditor attack and are useful tools in the tool box.
Another version of trust planning that can be very effective are trusts you create for others that contain “spend thrift clauses.” For example, you can create a trust for your child in your will that will make discretionary payments to your child for life. With a properly drafted spend thrift clause in this trust, the trust assets should be protected from your child’s creditors. This is a very important non-tax reason to set up trusts for heirs as part of your estate planning.
Looking for More Information?
For a full exploration of asset protection planning beyond this basic introduction, please consult legal counsel. As always, what we’ve shared here does not constitute legal advice and you should consult an attorney familiar with your own state law and legal circumstances before considering these strategies.