Ten Simple Estate Planning Strategies To Protect Assets

For the first time in years, I am hearing again from subscribers who seek to protect their assets from lawsuits and creditors. Those in the medical profession feel especially vulnerable. Other business owners and professionals are hurt by rising insurance costs or reductions in coverage. All are seeking other ways to protect themselves. In addition, many now are asking for estate planning strategies that will protect assets that are passed to their children.

Fortunately, you can protect wealth without venturing into the world of offshore trusts, shady operators, and unethical or illegal schemes. You also shouldn’t have to pay a fortune for an asset protection package.

Let’s start with a few general principles.

Your state law, with some supplements from federal law, controls the specifics of asset protection. Some states completely protect annuities and life insurance, for example, while other states protect them with limits. To be sure, you or a lawyer needs to check the local law.

Asset protection should not be done in a vacuum. Asset protection should be considered as part of estate, tax, and investment planning. This has several benefits.

Asset protection is only one of your goals. Making it part of your other planning ensures that you don’t sacrifice other goals to asset protection. Integrating the process also makes an asset protection plan more viable. A court is less likely to protect an asset if it appears a move was taken solely to thwart creditors. The plan would be viewed as a fraud on creditors. When you show tax, investment, or business reasons for the plan, a court is more likely to uphold it.

It is vital that asset protection planning be done before you have a real problem. Once there is a problem with creditors, a court will view any action you take as a fraudulent transfer. Take action before there is a court decision or creditors are beating on the door, and a court is more likely to support your actions.

Finally, don’t look for a magic bullet. It is better to rely on a collection of asset protection strategies than to have your wealth depend solely on one method.

Here is the toolbox from which to select asset protection strategies that will work for you.

Estate Planning Strategy #1

Insurance. Premiums are climbing, and more people are being denied various types of coverage. Yet, you should take what is available. Asset protection planning should supplement insurance, not replace it. An insurer will help defend you from claims and usually suggests ways to protect yourself. Also, don’t forget to have an umbrella liability insurance policy. This insurance still is inexpensive and covers you for liabilities not covered under other personal policies. It is well worth the cost.

Estate Planning Strategy #2

Spousal shield. Unless your spouse also signed on to a debt or is a co-defendant in a lawsuit, his or her property cannot be reached by your creditors. There are several ways to use this shield.

A simple transfer of title to your spouse works. There won’t be any gift taxes, because of the unlimited marital gift tax deduction. Of course, you cannot get the property back, and your spouse is free to do whatever he or she wants with it.

You also want to be sure that the property doesn’t come directly back to you if the spouse dies first. Instead, your spouse’s will should provide that the property will be transferred to a trust for your benefit that has a spendthrift clause, so that your creditors cannot reach the trust.

Another strategy is property held jointly as tenants by the entirety. Not all states recognize this type of title. In those states that do recognize it, creditors of one spouse cannot force the property to be sold. Only creditors of a joint debt can get the property. To get protection, the title must be tenancy by the entirety. Jointly held property and property held jointly with right of survivorship do not get this protection.

Each spouse should have sole title to some property for estate planning anyway. Otherwise, the $1 million estate tax exemption for the spouse without title to property is wasted.

Estate Planning Strategy #3

Estate planning vehicles. Family limited partnerships and limited liability companies can be excellent parts of estate plans. They reduce gift taxes, get assets out of your estate, and still allow you a lot of control over the assets. In addition, in most states the assets in the entity are protected from the creditors of the partners. Distributions from the entity could be claimed by creditors, but the creditors cannot force distributions, seize assets from the entity or seize a partner’s ownership interest.

Estate Planning Strategy #4

Annuities and life insurance. This protection varies from state to state. Some states fully protect annuities or the cash value in life insurance policies. Creditors might be able to get distributions as they are made, but they cannot seize the assets or force distributions. You might need to file for bankruptcy to trigger the protection. Check state law before making a purchase.

Estate Planning Strategy #5

Prepay for college. Section 529 college savings plans are protected to some extent from creditors in at least 19 states. The protection varies, and you might need to be a resident of the state sponsoring the plan to get the protection. Another protection is to name the student as the owner of the account, but then you wouldn’t be able to control the account or get the money back if needed. A good strategy might be to name your spouse as owner of the account.

Estate Planning Strategy #6

Create trusts. Irrevocable trusts usually protect assets from creditors of either the grantor or the beneficiaries of the trust.  They also ensure that the assets are out of your estate for tax purposes. A good asset protection trust should have a spendthrift clause, which shields assets from creditor claims. Spendthrift clause protection differs from state to state. Some provide unlimited protection; others limit the protection. Also, an independent party should be trustee.

Many asset protection planners recommend carefully choosing the location of the trust and its trustee. The most aggressive strategy is to locate the trust in a foreign country, especially one with strong asset protection laws. Courts, however, have found ways to break down the effectiveness of these trusts. Most asset protection planners acknowledge that the real benefit of an offshore trust is that many creditors will be discouraged by the time and expense involved in breaking the trust and will write off the debt.

Some states are offering asset protection trusts similar to those found offshore. These states include Alaska, Delaware, Rhode Island, and Nevada. Assets have to be in the trust for at least four years to be protected, and the trusts are too new to have been tested in the courts. Yet, they are a less expensive alternative to an offshore trust.

You could set up a simple irrevocable trust for the benefit of your children. Or you could have multiple layers. For example, a trust can serve as a partner of a family limited partnership. Or you can name someone as a trust protector, and the protector directs a trust that owns most of a family limited partnership. These multiple layered plans are expensive to create and maintain.

Estate Planning Strategy #7

Bankruptcy exemptions. Ideally you want to protect your assets without filing for bankruptcy. As a fallback, however, you should examine the bankruptcy exemptions in your state and consider arranging asset ownership to maximize protected assets.

Most states protect a home of up to some value from creditors in bankruptcy. In seven states, most prominently Florida and Texas, there is an unlimited homestead exemption. You can own a home of any value and have it protected from bankruptcy creditors. Some bankrupts have protected assets by purchasing expensive homes in Florida even after losing court cases.

Estate Planning Strategy #8

Retirement accounts. The protected amount for retirement accounts varies by state and by the type of account. In most states, IRAs receive a limited exemption while profit-sharing plans and corporate retirement plans are fully exempt. When a creditor claim seems likely, it might be possible to set up a business, create a retirement plan, and roll an IRA into the business retirement plan.

Keep in mind, however, that a bankruptcy bill rolling through Congress would limit the homestead and IRA exemptions in most states.

Estate Planning Strategy #9

Aggressively manage assets. Some assets are difficult to protect from creditors, yet you might be able to protect equity in the asset. For example, you can borrow against the equity in real estate and put the loan proceeds in a trust, family limited partnership, or other vehicle with more protection. A variation is to identify assets that are difficult to protect and sell them for cash. Then protect the cash.

Estate Planning Strategy #10

Consider a charitable trust. The charitable remainder annuity trust can be a great estate planning tool. It works with appreciated assets such as real estate or stocks. You contribute the asset to the trust and take a tax deduction for a portion of its fair market value. No capital gains taxes are due on the appreciation. You receive a regular annuity payment for life from the trust, and the amount left in the trust at your death goes to a charity you designated.

In a state that protects annuities, the income stream from this trust is likely to be protected in bankruptcy. A variation, known as a unitrust, pays a fixed percentage of the trust instead of a fixed amount. That provides inflation protection. Unfortunately, the unitrust might not get the protection an annuity trust receives.