Asset Protection Considerations

When working with clients to develop thorough and appropriate estate planning strategies, many issues need to be addressed:  guardians for minor children; minimizing or eliminating future tax liabilities; caring for elderly parents; designing structures for the education and support of minor children; confirming the appropriate beneficiary designations; assuring that advanced medical directives are in place; and many more.

One element of our financial/legal discussions with clients that has become increasingly important is the ability of our clients to protect themselves, and their children, from the claims of creditors.  This discussion of “asset protection” has risen up the menu of estate planning topics, and often takes precedence over many others.

The universe of potential creditors from whom “protection” is desired typically falls into three categories: the tort claimant (i.e., the person you hit with your car who is now suing you); the divorcing spouse; and the business creditor (e.g., the bank or landlord who may be suing you on a personal guarantee you signed). 

With professionals – such as doctors and other health care professionals – the subset of business creditors can include malpractice claimants.  Health care professionals are inclined to approach any asset protection discussion through the dark lens of the medical malpractice claim. In truth, they generally mirror the general population in that their exposure to loss occurs more frequently as the result of “garden variety” hiccups, such as:

  • Uninsured or underinsured property/casualty losses
  • Ill-advised investments
  • Personal guarantees of business obligations
  • Alimony and property settlement payments that could have been minimized with a prenuptial agreement
  • Uninsured sexual harassment or other employment-related claims
  • Estate taxes caused by inadequate estate planning
  • Victimization by fraud
  • Liability for breach of fiduciary duty (ERISA claims, director or officer liability, etc.)
  • Contractual indemnification obligations

Any asset protection strategy that does not address these risks is short-sighted.

COMPONENTS OF ASSET PROTECTION STRATEGIES

A comprehensive asset-protection strategy should include several components.  Some of these are set forth below.  These are, of course, in addition to common-sense liability avoidance.  

Use good judgment:  don’t permit underage drinking in your house;  recognize that  what may have previously been viewed as simple boorish behavior in the office may now be actionable sexual harassment; properly discharge your fiduciary obligations, as activities like serving on a board of directors is more than an honor, it is a responsibility that can entail legal risks; and so on.

Adequate Insurance Coverage

Regardless of other strategies that might be considered, liability insurance is always recommended as the cornerstone of asset protection. When selecting an insurance carrier, consider the strength of the carrier and its commitment to remaining in the market, the amount of insurance coverage and, arguably least importantly, the premium cost.

An asset-protection strategy should include a review of the adequacy of all insurance policies including life, disability, office overhead, automobile, homeowner’s, umbrella coverage and employment practices (to cover the increasingly common incidence of discrimination, sexual-harassment and other employment-related claims).  Identifying insurance gaps can be the most valuable asset protection service.

Tenants By The Entirety:

“Tenants by the entirety” is a mode of real estate ownership, applicable to principal residences only, and available only to married persons.  When residential real estate is owned as tenants by the entirety, the creditor of only one spouse cannot cause the residence to be sold to satisfy the debt.  Contrast this with simply joint tenancy where the home can be sold and half the proceeds applied to satisfy the debt.

Transfer of Ownership of Assets Within a Family

A common asset-protection strategy has been to gift assets from a “higher-risk” spouse to the “lesser-risk” spouse, or to children.  While this strategy continues to be effective, where husband and wife are both higher-risk (say,  a lawyer and a dentist, etc.), inter-spousal gifts can be ineffective. In such cases, using “spousal access trusts” is often a useful solution.

No major gifting program should be undertaken without coordination with proper estate planning.  That said, transferring assets (e.g., a personal residence) to the “lesser-risk” spouse often achieves both asset-protection and estate planning goals.

Building Up Value in Exempt Assets: 

State law exemptions permitted by the Bankruptcy Code should be considered as part of any asset protection strategy.  This is particularly true as some of the largest components of many clients’ estates (life insurance, qualified retirement plans, and a personal residence) are treated with varying degrees of exempt status under State law.[1]

The benefit of building up value in assets that are exempt in bankruptcy proceedings should always be examined in conjunction with other planning goals, such as estate tax minimization, probate avoidance, and so forth.

Family Limited Partnerships and Limited-liability Companies

Family limited partnerships or limited liability companies can offer significant asset protection in that, if properly structured, a creditor of a partner in a partnership (or a member in an LLC) can only receive a “charging order” against that individual’s interest in the partnership or LLC.  Typically, these entities are also attractive to clients as vehicles through which family property can be better managed or controlled, or through which ownership interests in property can be gifted to other family members at a discounted value so as to minimize federal gift tax complications.[2]

Such entities can also be a much more convenient way of transferring interests in real estate than by transferring percentage fee interests with the complications associated with mortgages, deed filings, transfer taxes, and title insurance.

Asset Protection Trusts: 

Asset-protection trusts have been suggested to clients as a technique that allows the “grantor” (the person who sets up the trust) to retain an ownership interest in the assets while simultaneously placing the assets beyond the reach of the grantor’s creditors.  In the past, these trusts were formed in exotic locales such as Liechtenstein or the Isle of Man or the Cook Islands.[3]  The significant costs associated with establishing these trusts, their inconvenience, their spotty track record of success in US courts, and the general sense of unease that comes with inadequate control over the gifted assets historically made these trusts unattractive to most clients

In recent years, the laws of a number of states (such as Nevada, Alaska, and South Dakota— 17 states in all have some flavor of asset protection legislation) were revisited to offer domestic forms of asset-protection trusts.  These trusts are an exception to the general law of trusts that holds that the assets in a trust that you establish for yourself will always be reachable by your creditors.

In forming a domestic asset protect trust (sometimes referred to as a “DAPT”), certain matters involving the establishment and ongoing operation of the trust need to be considered.  Typically, the trustee must be domiciled in the state that permits the asset-protection trust.[4]  As a practical matter, this is not a problem as many large banks have formed trust companies or have branches in such States.

Commonly, State laws authorizing these DAPTs do not immediately insulate assets from creditor claims, and they also exempt certain types of claims.  For example, under Delaware law, is ineffective as to current known creditors, and future creditors have a period of time to press their claims after the transfer of assets to the DAPT.  Exempt claims include those such as a spouse with claims for alimony or child support, and certain tort claimants whose claims arose before the establishment of the DAPT. 

Finally, there are federal gift tax implications to consider when establishing a DAPT.  Notwithstanding these limitations, asset-protection trusts are gaining traction.

Retirement Plan Assets

We have often seen that a client’s most valuable single financial asset may be his or her qualified retirement plan account or IRA.  The most common asset-protection-related questions we receive from these clients are these:

  • Are my qualified retirement plan assets protected from the claims of my creditors?
  • If I roll my qualified plan assets into an IRA, will they still be protected?

ERISA (the federal law that governs qualified retirement plans) prevents a creditor from seizing assets in an ERISA-qualified retirement plan to satisfy a judgment against the plan participant or beneficiary. Therefore, answering the first question requires determining whether the plan in question is an “ERISA plan.” Generally speaking, pension plans, profit sharing plans and 401(k) plans are considered “ERISA-qualified plans” and hence protected.

Recognize that the rules governing such plans require that the participant begin taking “required minimum distributions” (RMDs) at some point.  While the assets in the ERISA plan may be shielded from creditor claims, the RMDs, once paid to the participant, do not always enjoy the same protection.

Answering the second question involves an analysis of State law.  IRAs are not “ERISA plans” and are generally not insulated from the claims of creditors by ERISA.  State exemption laws again provide varying levels of protection for IRAs -- some providing full exemption with others providing an exemption to the extent necessary for the support of the IRA beneficiary and the beneficiary’s dependents.  Under Illinois law, IRAs are specifically made exempt from judgment creditors.[5]

CONCLUSION

Asset-protection issues have become an integral part of the estate planning conversation. In addressing these concerns, these considerations should be kept in mind: 

  • First, a review of the client’s overall insurance plan with a qualified insurance professional is critical to assure adequacy of coverage and to confirm that there are no “gaps” in coverage.
  • Second, any asset-protection strategy adopted must be integrated into an overall tax, financial, and estate planning program.

Please contact any member of the

Goldstine, Skrodzki, Russian, Nemec and Hoff, Ltd. Estate Planning Group

for assistance with your planning.

Written by: William J. Cotter


   [1]    Even though the Bankruptcy Code is a federal law, the amount of the homestead exemption to which a bankrupt person is entitled derives from that person’s State of residence, and these State laws vary considerably.  Florida, Oklahoma, South Dakota and Texas are among the States that have unlimited homestead exemption;  in Illinois it is limited to $15,000 per debtor.

   [2]    Much legislative hand-wringing has occurred during the past half dozen years, as Congress struggled to curb perceived abuses in this arena. On August 2, 2016, the Department of the Treasury issued long-awaited proposed regulations on the valuation of interests in family-controlled entities for estate, gift and generation-skipping tax purposes.  Expect this landscape to change soon.

   [3]   The reasons that such nations have been the hub of this activity is both interesting and beyond the scope of this white paper, but it has largely to do with sketchy tax treaties and short statutes of limitations on fraudulent conveyance claims.

   [4]    The legislative history of the laws that allowed for the adoption of such trusts reflects a clear effort to promote the State’s corporate trust industry as much as a desire to provide a tool for asset protection.

   [5]    Note that a recent Supreme Court decision, Clark v. Rameker, muddied the water by pointing to a different result for inherited IRAs instead of IRAs that you funded with “your own money.”

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