Seven Ways to Protect Your Assets from Litigation and Creditors
August 18, 2022
By Karen Goldberg
Implement effective asset protection techniques as soon as feasible. The goal of asset protection is to guard against unanticipated future claims, not previously filed claims or ones that are reasonably predictable.
Purchase InsuranceInsurance is crucial as a first line of protection against speculative claims that could endanger your assets. This coverage may include umbrella plans, errors and omissions insurance, professional liability/malpractice insurance, cyber liability insurance, or personal and homeowner's liability insurance.
Transfer AssetsCreditors or litigants cannot seize assets you do not own—assuming the asset transfer does not violate illegal conveyance laws. Giving assets directly or through an unbreakable trust to your spouse, children or other relatives is an easy and effective way to protect those assets. Choose the recipients wisely to avoid exposing the assets to creditors.
Re-Title AssetsRe-titling property is another simple but powerful strategy. For example, married spouses can legally hold a home as "tenants by the entirety," shielding the property from the personal debt of either spouse. However, this strategy does not offer any defense against the combined debts of a couple.
Make Retirement Plan ContributionsContributing the maximum allowed to qualifying retirement plans, such as 401(k)s, not only saves money for your future but also shields it from most creditors' claims. IRAs provide only a limited level of protection. In the event of insolvency, IRAs are shielded from creditors' claims up to a predetermined sum.
Create an LLC or FLPA very efficient strategy to redistribute wealth among your family while maintaining control is to contribute funds to a limited liability company (“LLC”) or family limited partnership (“FLP”). While they are often used for real estate and other assets, these company structures are an advantageous way of managing business interests. To use this technique (1) set up an LLC or FLP; (2) transfer assets to the entity; and (3) transfer membership or limited partnership shares to yourself and additional family members. This strategy makes the redistribution of wealth easier, while also significantly protecting the members’ or limited partners' assets because their personal creditors typically cannot seize the entity's assets.
Set Up a DAPTA domestic asset protection trust (“DAPT”) can be a valuable tool. It shields the assets that you transfer to the DAPT from creditors even if you are a discretionary beneficiary. Approximately one-third of states allow DAPTs; however, you are not required to live in a particular state to reap the benefits of a DAPT. A DAPT offers different levels of protection depending on the state. It is extremely important to properly structure and fund the trust because the courts could challenge the enforceability of a DAPT whose grantor lives in another state.
Create an Offshore TrustFor additional protection, one of the more complicated strategies is to set up an offshore trust. Comparable to DAPTs, offshore trusts are created in countries with advantageous asset protection legislation. These countries often do not recognize judgments or orders issued by American courts and can make it challenging for international creditors to enforce their claims. While offshore trusts are irrevocable, several nations permit a trust to become revocable after a certain period, which permits the collection of assets once the risk of loss has passed.
Take note of foreign reporting requirements. Compliance with appropriate reporting standards is crucial if you plan to use an offshore trust. For example, a U.S. owner of a foreign trust must make sure the trustee submits annual information returns, such as Form 3520-A. U.S. grantors and U.S. beneficiaries of overseas trusts also must file Form 3520 to report any interactions with the trust. In either case, noncompliance could trigger substantial penalties.
Asset protection is not meant to be a means of escaping your financial obligations or avoiding credible creditors. The goal is to protect your assets from misleading litigants or unjustified creditor claims and to distribute your wealth to loved ones in a way that is tax effective.