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Asset Protection

If you haven't done any asset protection planning, your wealth may be vulnerable to potential future creditors, and, should the worst happen, you could lose everything.

Lawsuits, taxes, accidents, and other financial risks are facts of everyday life. And though you'd like to believe you're safe, misfortune can befall even the most careful person. What can you do? First, identify your potential loss exposure, then implement strategies designed to help reduce that exposure without compromising your other estate and financial planning objectives.

This may include a review of the following:

  • Titling and Ownership of Assets
  • Liability Coverage
  • Long-Term Care Insurance Needs
  • Investment Solutions available

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In-Depth Asset Protection

  • First, a word about fraudulent transfers

    Part of your overall asset protection plan might include repositioning assets, making it legally difficult for potential future creditors to reach them. This does not, however, extend to actions that hide assets or defraud creditors. If a court finds that your asset protection plans were made with the intent to defraud, it will disregard those plans and make the assets available to creditors.

    How can you avoid running afoul of the fraudulent transfer laws?

    Make sure your plans are made for legitimate business purposes or to accomplish legitimate estate planning objectives
    Carefully document the legitimate business and estate planning purposes of any arrangements you make
    Put your plans into effect before you have any problems with creditors
    Do not implement a plan at a time when a lawsuit is imminent or pending or at a time when you have an outstanding debt that you believe you may be unable to pay

    Where the dangers lie

    Unexpected liability can come from just about anywhere:

    The IRS and other tax authorities
    Accident victims, including victims whose injuries were caused by the actions of minor children or employees
    Doctors, hospitals, nursing homes, and other healthcare providers
    Credit card companies
    Business creditors, including employees and former employees, governmental agencies, suppliers, customers, partners, shareholders, and the general public
    Creditors of other individuals, where you have cosigned or guaranteed obligations for those individuals
    Marital or other live-in partners

    Asset protection techniques

    There are three basic asset protection techniques: insurance, statutory protection, and asset placement. None of these techniques is a complete solution, but they may make sense as one limited component of an asset protection plan.


    The simplest way to cope with risk is to shift the risk to an insurance company. This should be your first line of defense. Before you do anything else, review your existing coverage. Then consider purchasing or increasing coverage on your insurance policies as appropriate. You should be adequately insured against the following:

    Death and disability
    Medical risk, including long-term care
    Liability and property loss (both personal and business)Other business losses
    Other business losses

    Statutory protection

    Creditors can't enforce a lien or judgment against property exempt under federal or state law. While exemption planning can't offer total protection, it can provide some shelter for certain assets.

    Both federal and state laws govern whether property is exempt or nonexempt in non-bankruptcy proceedings (separate federal and state laws govern whether property is exempt or nonexempt in bankruptcy proceedings). Generally, you can choose whether the federal or state exemptions apply. When looking at exemption laws, be sure to determine how much of an exemption is allowed for a particular property type. It may be completely exempt, exempt only up to a certain amount, or restricted somehow. Types of property often receiving an exemption include:

    Homestead (principal residence)
    Personal property
    Motor vehicle
    IRAs, pension plans, and Keogh plans
    Prepaid college tuition plans
    Life insurance benefits and cash value
    Proceeds of life insurance
    Proceeds of annuities

    Tip: In those jurisdictions that recognize ownership by tenancy by the entirety (TBE), creditors of the husband or creditors of the wife cannot reach TBE assets.

    Asset placement

    Asset placement refers to transferring legal ownership of assets to other persons or entities, such as corporations, limited partnerships, and trusts. The basis for this technique is simple--creditors can't reach property that you do not own or control.

    Shifting assets to the spouse who is less exposed to claims

    If you have high exposure to potential liability because of your occupation or business, it may be advisable for you to shift assets to your spouse. Your spouse would retain the assets that are subject to the exposure as their separate property, and you would retain assets that enjoy statutory protection, such as the homestead, life insurance, and annuities, as separate property. Furthermore, shifting assets to a spouse or children may help accomplish other estate planning goals.

    Caution: To avoid complications if your marriage ends in divorce, you and your spouse should agree to the division of assets in writing. This is especially important in community property states.

    C corporations

    If you own a business and aren't already a C corporation, changing your business structure to a C corporation will make it a separate legal entity in the eyes of the law. A C corporation owns the business assets and is responsible for all business debts. Thus, incorporating your business separates your business assets from your personal assets, so your personal assets will generally not be at risk for the acts of the business.

    Caution: The limited liability feature may be lost if, for example, the corporation acts in bad faith, fails to observe corporate formalities (e.g., organizational meetings), has its assets drained (e.g., unreasonably high salaries paid to shareholder-employees), is inadequately funded, or has its funds commingled with shareholders' funds.

    Caution: Several issues should be considered when selecting a form of business entity, including tax considerations. Consult an attorney and tax professional.

    Limited liability companies (LLCs) and partnerships (LLPs and FLPs)

    An LLC is a hybrid of a general partnership and a C corporation. Like a partnership, income, and tax liabilities pass through to the members, and the LLC is not double-taxed as a separate entity. And, like a C corporation, an LLC is considered a separate legal entity that can be used to own business assets and incur debt, protecting your personal assets from other nontax claims against the LLC.

    Professionals (e.g., doctors, lawyers, and accountants) face liability for damages resulting from their professional duties. While no business structure will protect you from personal liability for your professional activities, an LLP will protect you from the professional mistakes of your partners. Suppose one of your partners is sued, and the LLP is also named in the lawsuit. In that case, any malpractice judgment is the personal liability of the partner who's been sued but a business liability for you and the other partners. Your personal assets aren't at stake if your partner commits malpractice, although your investment in the business may still be at risk.

    An FLP is a limited liability partnership formed by family members only. At least one family member is a general partner; the others are limited partners. A creditor can't obtain a judgment against the FLP--it can only obtain a charging order. The charging order only allows the creditor to receive any income distributed by the general partner. It does not allow the creditor access to the assets of the FLP. Thus, a charging order is not an attractive remedy to most creditors. As a result, the limitation to seeking a charging order can often convince a creditor to settle on more reasonable terms than might otherwise be possible.

    Protective trusts, in general

    A protective trust can protect business and personal assets from most creditors' claims. A trust works because it splits ownership of trust assets; the trustee has equity ownership, and the beneficiaries have beneficial ownership. Essentially, a protective trust works like this:

    Example(s): Harry would like to leave property to Wendy. However, Harry fears that his creditors might claim the property before he dies and that Wendy will receive none of it. Harry establishes a trust with both himself and Wendy as the beneficiaries. The trustee is instructed to allow Harry to receive income from the trust until Harry dies and then distribute the remaining assets to Wendy. The trust assets are then safe from being claimed by Harry's creditors so long as the debt was entered into after the trust's creation.

    Under these circumstances, any of Harry's creditors could reach assets in the trust only to the extent of Harry's beneficial interest in the trust. Say that Harry's interest in the trust is a monthly fixed income distribution of $1,000. Assuming Harry's creditors obtained a judgment, they would only be entitled to the $1,000 monthly.

    Irrevocable trusts

    As the name implies, an irrevocable trust is a trust you can't revoke or change. Once you have established the trust, you can't dissolve it, change the beneficiaries, remove assets from it, or change its terms. In short, you lose control of the assets once they become part of the trust. But, because the assets are out of your control, they're generally beyond the reach of creditors too. In the trust, you may further protect those assets from your beneficiaries' creditors by using special language (known as a spendthrift clause).

    Caution: Unlike an irrevocable trust, a revocable trust provides the assets in the trust with absolutely no legal protection from your creditors.

    Offshore (foreign) trusts

    It's possible to transfer assets to trusts that are formed in foreign countries (certain countries are preferred). While the laws of each country are different, they share one similarity, they make it more difficult for creditors to reach trust assets.

    Here's how it works: For a creditor to reach assets held in a trust, a court must have jurisdiction over the trustee or the trust assets. Where the trust is properly established in a foreign country, obtaining jurisdiction over the trustee in a U.S. court action will not be possible. Thus, a U.S. court cannot exert any powers over the offshore trustee.

    So, the creditor must commence the suit in the offshore jurisdiction. The creditor can't use its U.S. attorney; it must use a local attorney. Typically, a local attorney will not take the case on a contingency fee basis. Therefore, a creditor must be prepared to pay the foreign attorney upfront if it wants to pursue litigation in the offshore jurisdiction. To make matters even less convenient, many jurisdictions require the creditor to post a bond or other surety to guarantee the payment of any costs the court may impose against the creditor if it is unsuccessful. Taken as a whole, these obstacles have the general effect of deterring creditors from pursuing action.

    Domestic self-settled trusts

    The laws in Alaska, Delaware, and a few other states enable you to set up a self-settled trust. Alaska was the first state to enact such an anti-creditor trust act, and Delaware quickly followed. Hence, this type of trust is often called an Alaska/Delaware trust (sometimes called a domestic asset protection trust or DAPT). A self-settled trust is a trust in which the person who creates the trust (the grantor) can name themself as the primary beneficiary. These trusts give the trustee wide latitude to pay as much or as little of the trust assets to any or all of the eligible beneficiaries as the trustee deems appropriate. The key to this type of protective trust is that the trustee has the discretion to distribute or not distribute the trust property. Creditors can only reach property the beneficiary has the legal right to receive. Therefore, the trust property will not be considered the beneficiary's property, and any creditors of the beneficiary will be unable to reach it.

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