By: Randall A. Denha, J.D., LL.M.
We’ve all heard that planning doesn’t just stop after you prepare an estate plan. There is much more to do. Families change. Circumstances change. Children change. All of these instances require a constant and often routine tweaking of your estate and financial affairs. Planning is a process and, quite frankly, never stops. For some reason, many people seem to think that once they’ve concluded their personal estate planning that they have also shielded their assets from creditors. I wish it were that easy! What clients are assuming but not saying is, “can you protect my hard work from giving too much to Uncle Sam as well as protecting my hard work from the clutches of creditors?” The answer is yes.
Asset protection is a form of insurance. You insure your car, your house, your health, your life. You also should insure your other assets, your savings, your investments and your business. No matter how astute a business person you are, or how skilled you are as an investor, or how lucky you are with your lottery tickets, it does little good if you leave your assets exposed for lawyers to sink their teeth into. The United States is litigious, and the more assets people think you have, the more tempting a target you will become for frivolous lawsuits.
Asset protection planning is used to protect personal assets from business deals gone bad, divorce, auto accidents, palimony suits, litigious persons, disgruntled employees and numerous other collection efforts. For a professional, such as a surgeon, asset protection planning allows the physician to protect his or her loved ones by protecting personal assets, whose value exceed the policy limits on malpractice insurance. For a business owner, asset protection planning allows you to protect your personal assets from business deals gone badly, whether partnership disputes or lawsuits by customers, vendors or disgruntled employees. For an elderly person, who may need expensive nursing home or assisted living care, asset protection planning can be used to transfer assets to children as part of a plan to make an estate Medicaid-ready. In short, asset protection planning allows you to build a wall around your assets, and thus avoid or reduce the risk of the loss of all that you have worked a lifetime to build and grow.
There are many techniques and strategies that are used to help create this shield of protection. Here are a few of the popular ones:
• Use Business Entities. If you’re an entrepreneur of any kind, it’s important to separate your personal assets from those of your business. If you neglect to take specific legal steps to create a separate business entity, such as a corporation, limited liability company (LLC), or limited partnership, a simple business dispute could well cost you everything you own. While corporations have been around for years and provide protection for its owners, they still have some restrictions. A far better asset protection strategy is to use limited liability companies or LLCs for its charging order protection. If your corporation loses a suit, a judge could award a number of the shares of the business to the creditor. This gives them access to your books. With an LLC, even if the plaintiff gets a membership interest, he can’t force a distribution of cash, but he still gets taxed as if he received it. This “poison pill” can help you prevent a lawsuit or settle on favorable terms.
• Own Insurance. Some professions generate more exposure to liability than others. If you are a physician, financial or a professional in any other field that generates a lot of lawsuits for malpractice, keep your errors and omissions coverage paid up, and, if you can afford to, invest in extra or expanded coverage. But don’t stop there – you also need to enact these kinds of coverages:
• Homeowners Insurance. This type of insurance helps cover you if someone is hurt on your property. Choose a deductible you can cover with your savings, and make sure liability coverage is adequate in case someone gets hurt on your property and decides to sue you.
• Commercial Liability Insurance. This type of insurance protects your business if someone gets hurt on the premises, or is injured as the result of an action by an employee.
• Worker’s Compensation Insurance. This is mandatory in most jurisdictions. Worker’s compensation protects you and your workers alike by ensuring that there’s enough liquidity in place to take care of any employee who gets hurt on the job, and that the expenses don’t come out of your pocket.
• Auto Insurance. Buy enough additional coverage for your auto insurance so that you will have meaningful protection in the event your vehicle is involved in an accident and generates a lawsuit. As a general rule of thumb, make sure your total liability coverage is at least equal to your total assets.
• Umbrella Coverage. This is backup insurance that can be used in the instance that your other coverages are inadequate. In the event that your auto, homeowners, or other liability coverages are exhausted, umbrella coverage pays benefits up to the limit of the policy. For example, if you have $1 million in auto liability and get hit with a $2 million judgment, your umbrella policy will pick up the additional $1 million in coverage. Otherwise, the plaintiffs could start coming after you to seize assets for damages. Typically, these policies get underwritten for $1 to $5 million in face value. It’s usually very affordable.
• Long-Term Care Insurance. This protects you against the financially devastating costs of in-home or nursing home care for chronic ailments, such as dementia, Alzheimer’s, strokes, paralysis, multiple sclerosis, spinal cord injuries, and the like. Medicare doesn’t provide much coverage for these afflictions, and most major medical insurance policies don’t provide any. Without long-term care insurance, you could be on the hook for more than $200 per day in nursing home costs – until the expenses drive you into poverty so you can qualify for Medicaid. The longer you wait, the higher the premiums get. Additionally, you could develop an ailment that would preclude you from getting coverage, or at least make it prohibitively expensive. Alternatively, consider purchasing long-term care insurance for your parents if you’ll otherwise be on the hook for this expense.
• Use Retirement Accounts. Federal law provides unlimited asset protection to ERISA-qualified retirement plans, and up to $1 million in assets in an IRA in the event of bankruptcy. Some states provide even more protection to IRAs, though some states have opted out of the 2005 Bankruptcy Reform Act’s federal bankruptcy exemptions and exempt a lesser amount.
• Use Annuities and Life Insurance. Some states provide significant protection to annuity balances and to assets in cash value life insurance policies. For example, in Michigan life insurance and annuity contracts are not subject to the claims of creditors of any beneficiary other than the insured so long as there is a clause in the contract that states so. On the other hand, Florida provides an unlimited protection to the cash value.
• Use Irrevocable Trusts or Simply Make Gifts. Creditors cannot seize assets that you no longer own. Therefore, consider transferring ownership to irrevocable trusts, from which family members may be able to draw an income or give the assets to family members outright, as part of a strategic gifting program. As of 2012, you can give away up to $13,000 per person without incurring a gift tax liability, subject to a lifetime gift tax exclusion of $5.12 million. If you are in a high-risk profession, consider transferring assets to your heirs early – call it an “advancement.” If you don’t expect to need the money while you’re alive, you might benefit from watching them enjoy the inheritance.
• Titling. If you own your home with your spouse as tenants by the entirety, both you and your spouse own an indivisible interest in the home. If only one of you is named in a suit, creditors cannot force the other spouse to sell his or her interest in the house. Because the interest is indivisible, this can help you protect home equity where state law doesn’t provide a sufficient homestead exemption. Michigan law recognizes this form of ownership and is by far and wide the preferred form of ownership for married couples.
Please remember that you can’t wait until the lawsuit is imminent before you undertake any of the techniques discussed. If you do, the courts could rule that any transfer of funds into a protected class is a fraudulent conveyance and disallow the transfer, leaving those assets exposed. Above all, don’t become a tempting target, and avoid displays of conspicuous consumption. This could attract the wrong crowd (i.e. lawyers) and cause them to take a plaintiff’s case where they would otherwise pass on it.
THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION. THE MATERIAL IS BASED UPON GENERAL TAX RULES AND FOR INFORMATION PURPOSES ONLY. IT IS NOT INTENDED AS LEGAL OR TAX ADVICE AND TAXPAYERS SHOULD CONSULT THEIR OWN LEGAL AND TAX ADVISORS AS TO THEIR SPECIFIC SITUATION.