The New Asset Protection Rules for Estate Planning

A new bankruptcy law is making its way through Congress this spring. It makes major changes in the protection afforded to some assets. Asset protection strategies for Estate Planning need to be reviewed in light of the new law.

The bulk of the law addresses the bankruptcy process. In general, it is harder for someone whose disposable income exceeds the average in his or her state to have debts erased in bankruptcy liquidation. Instead, many debtors will be required to make payments for up to five years under a bankruptcy reorganization plan supervised by a court. Certain fixed obligations and an amount for allowable living expenses as determined by the  IRS are subtracted from income to determine the amount to be repaid each month.

Some debts cannot be reduced or extinguished under the new law: alimony, child support, most taxes, and student loans. Some of the traditional estate planning exempt assets also have their treatment changed under the new law.

Retirement plans. Employer retirement plans remain exempt from creditor claims under the law up to $1 million. In addition, IRAs clearly are exempt. Under the previous law, the status of IRAs was not clear. Their status was left up to each state. Ironically, in early April the Supreme Court settled the issue and ruled that IRAs had the same status as employer retirement plans under the old law. Also under prior law, the exempt amount for retirement plans was up to the courts, using the standard of a reasonable amount for living expenses. Now there is a fixed exempt amount.

Homesteads. Previous law left it up to each state to determine how much of a home’s value should be exempt from creditors. Some states provided no exemption or only a modest amount. Other states, such as Texas and Florida, allowed virtually unlimited homestead exemptions. Wealthy people anticipating creditor problems could buy mansions in Florida or Texas, establish residency, and shield considerable wealth from their creditors.

The new law still permits each state to determine the amount of its homestead exemption. But the exemption applies only if the debtor owned the home and established residency in the state for at least 40 months before the bankruptcy filing. That still lets those with wealth and some foresight to shelter some of that wealth in real estate.

Asset protection plans. Special trusts, known as asset protection trusts, are available under the laws of some foreign countries and states such as Alaska, Delaware, Rhode Island, Nevada, and Utah. An individual can put assets into such a trust, and they will be safe from creditors, though the individual can continue to benefit from the assets. The new law continues to provide an unlimited exemption for assets in the asset protection trusts.

The law also does not change the treatment of estate planning assets transferred to spendthrift trusts for the benefit of others, such as a spouse and children. In many states, wealth is protected from the creditors of a beneficiary if the trust has a spendthrift clause. Some states limit the amount that is protected by a spendthrift clause. Other states protect an unlimited amount, while a few states do not exempt spendthrift trusts.

Automobiles. Car loan and lease payments generally cannot be forgiven if the auto was purchased within two and a half years of the bankruptcy. This can be helpful to some people. The car can be kept, and the required auto payments would reduce the amount of money that would be paid to other creditors. The car payments also might reduce discretionary income below the average for the state so that the debtor is allowed a liquidation of debts instead of a reorganization.

The new law re-writes federal bankruptcy rules. Anyone with an asset protection plan needs to consult with an attorney to determine if the plan needs changes.