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6 Easy and Legitimate Ways to Protect Assets

Last update on: Aug 10 2020
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Many people consider asset protection to be part of an estate plan. Protecting wealth from creditors, lawsuits, and other claims during life can be just as important as protecting it from taxes. A good plan also can protect assets from claims against your heirs.

Assets can be protected without elaborate schemes that involve multiple levels of trusts, entities in obscure countries, and the like. In fact, while many of those schemes make it harder for others to get your assets, it is far from impossible. Courts are becoming more willing to hold people in contempt until they order that their assets be disgorged from such schemes.

The simple ways of protecting assets changed in recent years because of a new bankruptcy law and other developments. Here are the easy, legitimate ways to protect assets.

Homestead exemption. This remains the classic asset protection strategy because eight states provide unlimited or nearly unlimited protection for a principal residence. No matter the value of the home, creditors cannot touch it. The most used states are Florida and Texas, but also on the list are Arkansas, Iowa, Kansas, Oklahoma, South Dakota, and Washington, D.C.

In the past it was common for someone who was on the verge of a big judgment or other claim to purchase a very expensive home in Florida or Texas. The recent federal bankruptcy law makes the strategy a bit more difficult. To obtain a state’s unlimited bankruptcy protection, you must have owned the home (or another in the same state) for a minimum or 40 months before the judgment. Also, you must live in the home at least two years after buying it. You must establish the state as your principal residence, not a place where you spend a few weeks during the year.

If you don’t meet those qualifications, the homestead exemption is only $125,000 under federal bankruptcy law.

Retirement accounts. This is perhaps where the biggest changes were made. Three sets of laws govern the protection of these accounts: federal pension law (ERISA), federal bankruptcy law, and state laws.

Previously, ERISA gave unlimited protection against creditors to most employer retirement accounts but not IRAs. The Supreme Court ruled that ERISA treated IRAs the same as employer plans. In 2005 the new federal bankruptcy law also provided an exemption for most IRAs. State law might protect retirement accounts from gaps in the federal law. Some states provide unlimited protection for all retirement accounts. Others provide no or limited protection. Some still do not protect IRAs while providing some protection to employer pensions and insurance annuities.

Here is how the protection of retirement accounts stands.

Traditional and Roth IRAs are protected in bankruptcy up to $1 million. But the limit applies only to contributions and earnings. There is unlimited protection for balances rolled over from employer plans such as 401(k)s. Also, the limit is increased for inflation annually and also can be increased at the discretion of the Bankruptcy Court.

In essence, all traditional and IRA accounts now are protected in bankruptcy. It is almost impossible to have accumulated $1 million through only annual contributions and earnings on them. Large IRAs almost always are the result of company plan rollovers, and those are fully protected.

To ensure the bankruptcy protection, it is best to keep good records of where IRA contributions came from or to roll over company plans to separate IRAs instead of mingling them with other IRAs.

SEPs and SIMPLE IRAs are considered employer plans, so they receive the unlimited protection.

Keogh and solo 401(k) plans for self-employed individuals who have no employees participating in the plans receive no protection under ERISA but receive the unlimited protection in bankruptcy.

But the federal bankruptcy law protects retirement accounts only in bankruptcy cases. For other kinds of judgments and creditor actions, ERISA and state law apply. Most employer plans receive full creditor protection under ERISA. But as noted above self-employed plans with no other employees do not receive ERISA protection.

The April 2005 U.S. Supreme Court decision holding that IRAs have the same protection as employer accounts helps in a number of states that provide little or no creditor protection for IRAs. But some asset protection advisors believe ERISA still gives more protection to employer plans and recommend leaving assets in an employer plan such as a 401(k) instead of rolling it over to an IRA when asset protection is the prime consideration.

That has some trade offs. You might get higher asset protection in the 401(k) (if a former employer allows you to maintain the account). But most 401(k) plans do not allow beneficiaries the equivalent of a stretch IRA to take maximum advantage of tax-free compounding.

In any case, remember that the protection applies only while money is in the retirement plan. Distributions, including required minimum distributions, are fair game for creditors. Even hardship distributions from a 401(k) can be sought by creditors.

Alaska trusts. Also known as asset protection trusts, these actually are available in seven states (Alaska, Delaware, Nevada, Rhode Island, Utah, Oklahoma, and Missouri). You do not have to be in one of these states to use the trusts. Only the trustee has to be resident in the state. These offer more creditor protection than traditional trusts do and almost as much protection as the exotic offshore trusts that are heavily marketed by asset protection specialists. The trusts purport to keep the assets safe from creditors while allowing the trust creator to benefit from the assets.

The trusts probably are not 100% creditor proof. Their main advantage according to many asset protection specialists is to put obstacles in front of creditors so that they will settle for less than the full claim.

Other trusts. When a trust is created for someone else, such as a child, many states still recognize spendthrift trusts that protect trust principal from creditors of the beneficiary. Some states provide unlimited protection, but many limit the amount of principal that can be protected to $250,000 or $500,000.

Automobiles. The federal bankruptcy law does not allow car lease and loan payments to be wiped out. The debtor must continue to make the payments. That also means the debtor can keep the vehicle, and the money needed to make the payments reduces the bankruptcy estate available to other creditors. It creates something of an incentive for people with creditor problems to have current, expensive cars that either are leased or have large loans against them.

Joint property. In some states, jointly-held property might be safe from creditors. If a state recognizes “tenancy by the entirety” between spouses, creditors of one spouse cannot seize all or part of the property. With other types of joint ownership, creditors of one owner might be able to get title to half the property or force a sale.

These simple strategies provide ample protection for most of us. They also should be supplemented with adequate amounts of homeowners and umbrella liability insurance. Also, any liability insurance appropriate for your business or profession should be a first line of defense. Before undertaking any strategy, meet with an estate planner or asset protection specialist in your state. Small details often determine whether or not an asset is protected from creditors.

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