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Tuesday, May 25, 2010

Protecting Your Assets from Lawsuit- Part V

In this final article in this series on how best to protect your assets against a lawsuit, I want to cover one final area as well as help you develop a coordinated asset protection strategy.

Protecting your home. Protecting your home against lawsuit may be one of the biggest challenges. Most couples hold title to their home under ‘joint tenants with rights of survivorship’. This means that if one spouse dies, the home automatically transfers to the surviving spouse without going through probate. Yes, it’s simple but exposes what, for most people, is their most valuable asset to lawsuit. To complicate matters, most states provide homeowners a ‘Homestead Exemption’ which significantly reduces property taxes. If you were to transfer title into a trust, or LLC, you’d likely no longer be eligible for the exemption…a high price to pay over the life of your home. Most mortgages also have a ‘due on sale’ clause that requires you pay off your mortgage should you transfer title out of your name. There are some possible strategies:
  1. If you are in an occupation considered ‘risky’ from a lawsuit perspective such as a physician, you could transfer title to your spouse. If you receive a judgment against you that exceeds your insurance limits, this strategy may provide the protection you need. One weakness is that there is no protection against judgments directly against your spouse.
  2. You could take out a large loan against your home and invest the proceeds (your equity) in one or more of the strategies we’ve already discussed. In effect, your home is now much less valuable or a target of would-be creditors. The weakness here is that you must make large mortgage payments.
  3. In my book, J.K. Lasser’s New Rules for Estate & Tax Planning, I discuss a little-know titling for married couples called, “Cross Contingent Remainder Deeds”, available in some states that prevents creditors from forcing the sale of your home unless the judgment is against both spouses.
To Do: While protecting your home may be a challenge, it may also be your most valuable asset. Consider whether one or more of the above strategies would be appropriate.

We’ve covered a lot of ground in this series and it would be easy to get overwhelmed and do nothing. As a result, at some time in the future, you may find yourself in a situation in which you wish you had taken action. Consider approaching asset protection one of two ways:
View it as a ‘process’ whereby you create ‘building blocks’ of asset protection. Start by listing all of your assets and liabilities on a piece of paper. For a form, visit the Resource Center at www.welchgroup.com; click on ‘Links’, then ‘Asset/Liability Review’. Decide what assets you feel need protecting now and begin with the simplest and least expensive strategy. As you acquire additional assets, you’ll revise and update your strategy periodically.
Work with a professional who has expertise in the area of asset protection. There are a number of attorneys who are skilled in this area as well as some financial advisors and accountants.

Most important is that you implement a plan customized to your situation BEFORE you realize you need one.

Tuesday, May 18, 2010

Protecting Your Assets from Lawsuit- Part IV

Protecting Your Assets from Lawsuit- Part IV

Thus far in this series on protecting your assets from a lawsuit, we’ve covered lifestyle issues, insurance planning, federal and state exemptions, titling of assets and the use of trusts. Legal documents are another way to protect your assets and today I’ll cover three categories: legacy planning, life insurance planning and prenuptial agreements.

Legacy Planning. When I review the wills of new clients, the documents often leave assets outright to the surviving spouse or, if there is no surviving spouse, to the children at a young age, say 21 or 25. A transfer directly to the surviving spouse continues to subject those assets to a potential lawsuit. As for the children, outright distributions at a young age expose assets to two risks. First, in my experience, many people in their twenties are ill-equipped to handle large sums of money and will either spend the money or invest it poorly. Second, the divorce rate in America continues to hover above 50%. Leaving your assets directly to children can expose those assets to a future divorce. Combine the odds of a divorce with the odds of a lawsuit during an adult child’s lifetime and you can easily see the importance of developing an asset protection strategy. In our practice we developed a concept we call, “Legacy Trust with Asset Protection Attributes”, whereby assets, at death, are transferred to a trust for the benefit of the surviving spouse or children for their lifetime. They receive monthly cash flow from the trust as well as principal distributions for predetermined events or situations…education, health, down payment for the purchase of a home…for instance. Should the trust beneficiary be threatened by a divorce or lawsuit, the trust language shields trust assets.
To Do: Take a moment to determine the total value of your estate including life insurance; review your will to determine how your assets will be left to your heirs; and decide if a Legacy Trust is a strategy worth considering.

Prenuptial Agreements. I’m sure you’re all familiar with the concept of a prenuptial agreement whereby couples, prior to being married, sign an agreement limiting the transfer of assets should the couple later divorce. This is most typical where one or the other or both of the couple have children by a previous marriage. We have also used a prenuptial agreement in cases where a child is expected to inherit substantial assets either outright or in the form of a family business interest.

Life Insurance. From an asset protection perspective, one of the mistakes I see people make is to, inadvertently or otherwise, name their ‘estate’ as the beneficiary of their life insurance. In one case, a husband did this and also did not have a will. As a result, the insurance proceeds were distributed according to state law and resulted in $500,000 going outright to the widow (no asset protection!) and $500,000 being held under a state conservatorship for the nine-year-old son until he turned 19 at which time he’d receive his money including all the growth, outright. I’m guessing you can see the problem here.
To Do: Make certain that your life insurance has a named beneficiary and, for asset protection, consider the advisability of using an Irrevocable Life Insurance Trust as both the owner and beneficiary of the policy.

Protecting Your Assets from Lawsuit- Part III

The way most people title their assets does little to protect them in the event of a legal judgment. The three worst ways to own property, from an asset protection point of view, are in your own name, joint ownership or in a partnership.

Owning assets in your name. The main advantages include simplicity and flexibility but you have absolutely no protection from a lawsuit.
Joint ownership of assets. Joint ownership actually increases your risks of fallout from a lawsuit. For example, if you own a rental property with your friend and he receives a judgment unrelated to the apartments, his creditors could force the sale of the property or become your partner…their choice! If they choose to force a sale of the apartments, you will receive your share but the timing of the sale could produce poor results.
Owning assets in a partnership. Owning assets in a partnership may increase your liability exposure even more than ownership in your own name or joint ownership! This is because in a partnership, it’s possible for you to be held legally responsible for the misdeeds of one of your partners! Not only could the creditor take his share of any partnership assets, but they can come after your share of partnership assets as well. Under certain circumstances, the creditor can breach the partnership and seize personal assets.

The solution is to rethink how you hold title to your assets. While you have a number of good options, perhaps the best choice is what is called a Limited Liability Company or LLC. LLCs are easy and inexpensive to set up and easy to maintain, and are treated as a separate entity or ‘person’ from a legal perspective. This means that assets held within your LLC is segregated from other assets and cannot be seized by creditors with a judgment not related directly to that LLC. Alternatively, if there is a judgment related directly to that LLC, while the LLCs assets are exposed, assets outside the LLC are not. The idea is to ‘segregate’ assets from each other which means you may want to hold assets in more than one LLC. For example, you may want one LLC to hold your ‘risky’ assets such as a rental property, boats, airplanes, recreational vehicles and another LLC to hold ‘safe’ assets such as your personal investment accounts, jewelry and antiques.

Beyond the LLC, the most popular choice of legal entity for asset protection is the Family Limited Partnership or FLP. FLPs are typically more complex and expensive to set up and manage than LLCs but also offer some additional advantages. There are also Domestic Asset Protection Trusts and Foreign Asset Protection Trusts that are sometimes used by wealthy families or those whose occupation places them at greater risks, such as physicians. While beyond the scope of this column, these topics are covered in my book, J.K. Lasser’s New Rules for Estate & Tax Planning.

To Do: Review a list of your assets and decide which should be held in an LLC for ‘risky’ assets and which should be held in an LLC for ‘safe’ assets.
Notice to Readers: In last week’s column, I discussed the liability risk of serving on for-profit and non-profit boards. A reader correctly pointed out that Alabama has statutes that significantly limit liability for non-profit board members.

Protecting Your Assets from Lawsuit- Part II

Last week I began a series on asset protection by discussing how you can reduce your risk of lawsuit through making changes in your lifestyle and protect assets by purchasing an umbrella insurance policy. When working with our clients, we do a Liability Risk Assessment whereby we attempt to determine if there are any obvious liability risks that need to be addressed with a particular strategy. I have had people tell me that they are not concerned about liability because if they feel threatened, they’ll simply transfer assets out of their name. This won’t work because of the federal ‘fraudulent transfers rule’ that states that funds transferred in an attempt to avoid creditors is illegal and the court will order the transaction be reversed.

Professional Liability Insurance. If you own a business, you’ll want to explore professional liability coverage which may come in a variety of forms including malpractice insurance (doctors, lawyers and other professionals), errors and omissions, product liability, premises liability coverage. From time to time, you may be asked to serve on various boards of either non-profit or for-profit organizations often serving with little or no pay. This can be very dangerous to your wealth. Generally, my recommendation is to avoid such appointments. If you are considering joining a board, make certain there is significant Officers and Directors liability insurance. Remember, as a director, you are liable for the misdeeds of the people who are running the organization and rarely do you have access to much information about their activities. I have a personal friend who forfeited hundreds of thousands of dollars after the board on which he served received a massive judgment.
To Do: Get with an insurance agent who specializes in commercial insurance and have him or her do a complete insurance review with particular emphasis on liability coverage.

Beyond insurance, both federal and state law provide a variety of protections that are vital that you know about and consider taking advantage of to protect your assets from lawsuit.

Federal Exemptions. Federal law protects all assets held in certain retirement plans including company sponsored profit sharing, 401k, 403b and pension plans (Employee Retirement Income Security Act- ERISA). In addition, in a law passed in 1995 (Bankruptcy Abuse Prevention and Consumer Protection Act), Individual Retirement Accounts (IRAs) are exempt from creditors for up to $1 million if the owner files for bankruptcy protection. Assets rolled over from a qualified plan such as a company retirement plan to your personal IRA do not count towards this $1 million limitation and remain fully protected from a law suit.
To Do: Consider shielding assets by investing through retirement plans. If you want to invest primarily in alternative investments such as real estate, oil and gas, or non-public business enterprises, consider setting up a self-directed IRA. You’ll need a custodian who specializes in these types of accounts.

State Exemptions. Each state has its own set of exemptions laws that provide a varying level of protection of assets from bankruptcy. For a state-by-state summary, visit the Resource Center at www.welchgroup.com; click on ‘Links’, then State-by-State Bankruptcy Exemption Laws.