Growth is Great, but What About Asset Protection?

Prudent wealth management techniques are not for the affluent alone.

By Seamus Smith

There are many ways that people can lose their assets, including frivolous lawsuits and other litigation, accidents, divorce, and bad business deals. For those willing to take time for asset-protection planning, it is well worth the peace of mind and could even pay for itself many times over in the event of a creditor problem. 

Asset-protection planning is not just for the wealthy. We live in a litigious society. Everyone is aware of horror stories in which people lost assets that they did not deserve to lose. That, unfortunately, is just the world that we live in. People often come to us after finding themselves being sued and ask how to protect their assets, but by that time, unfortunately, it’s usually too late. Asset protection needs to be implemented in advance. When you are being sued, one of the first things that the plaintiff’s attorney will look at is what assets might be available. 

There are all kinds of assets that automatically receive protection, but the assets generally need to be protected in advance of a lawsuit. Some states provide extensive protection for a homestead, like Kansas, or tenancy-by-the-entirety protection for assets of a married couple, like Missouri. Most states provide some kind of protection for insurance and most provide extensive protection for tax-deferred retirement accounts. Retirements accounts also receive significant protection under federal law. 

For those who are exceptionally high-risk targets like physicians, business owners and the affluent, more complex planning may be warranted. For example, some business entities, such as limited liability companies and limited partnerships, can be used for asset-protection purposes. Traditionally, these business entities were used to protect a business owner from risk related to an active business. The entities can also be used to provide protection for the assets inside the entities from creditors of the business owner. 

Generally, if a creditor obtains a judgment against you, the creditor can then use the judgment to seize your assets. For example, if you have a bank account, the creditor could access the account to settle the judgment. If instead, you own an interest in an LLC or LP that has been properly structured and maintained, the creditor cannot seize or force the sale of your interest in the entity or the assets within the entity itself. The creditor can only obtain a charging order against your interest. The charging order is essentially a right to obtain distributions made from the entity on account of your interest. Presumably, you have installed yourself or another trusted person as manager of the entity and no distributions will be authorized if there is a charging order. This creates a catch-22 for creditors: If a creditor goes to the cost and time of obtaining a charging order, it may not generate any actual recovery for the creditor. The creditor may even recognize phantom income with respect to the entity interest if it obtains a charging order. 

Foreign-asset protection trusts have also been a popular tool for the affluent. Offshore trust locations were ideal for a long time because domestic law did not provide creditor protection for self-settled or funded trusts and the distant locations created jurisdictional problems for judgment enforcement. This began to change a little over 20 years ago, when states started adopting laws specifically granting asset protection for self-settled trusts. More than 15 states now offer some kind of asset protection for self-settled trusts, but the selection of a state should be deliberate. The protection offered by some states is considered quest-
ionable while other states, such as Nevada, are considered more reliable for protection. The use of a domestic trust over a foreign trust may save fees and avoid geographic locations more prone to civil unrest and that have lax financial regulatory and reporting systems. 

Self-settled trusts entail some complexity, but it may be worth it for high-risk individuals. The trusts also work best if proactively implemented, just like other planning techniques. Federal bankruptcy law provides a 10-year creditor lookback for self-settled trusts, and most states have lookback periods of at least a couple years. 

It is a dangerous world out there, but the good news is that there are options for asset protection for those willing
to plan.  

About the author

Seamus Smith is a lawyer with Creative Planning Legal in Leawood, Kan.
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