How to Protect Your Assets and Sleep at Night
John Smith, a partner at a big international law firm, is nervous. He used to be scared of what could happen if someone successfully sued him or his firm for everything he owned. Now he is worried about the steps he took to protect his money.
Smith, who asked that his real name not be used, “got rid” of his assets through a series of legal agreements, trusts and partnerships that transferred ownership of his house, brokerage accounts, life insurance policies and other assets to his wife and children.
The strategies he used--generically referred to as “asset protection techniques”--are designed to shelter assets from creditors and litigants, and save Smith a substantial amount in taxes as well. But they could backfire.
As Smith sees it, two things could go wrong: He could get divorced, and his wife, who now has title to most of his money, could walk away with a bundle. Or, he could get sued and a judge could deem the asset transfers “fraudulent conveyances,” and demand that he unwind the deals. Some are impossible to unwind, so he could end up being held in contempt. At worst, he could even lose his license to practice.
“I still have mixed feelings about this,” Smith says. “But I really didn’t see any good alternative.”
Smith is an example of a growing number of wealthy professionals who are turning to complicated, controversial and expensive asset protection strategies out of fear that they will lose everything they have saved to a lawsuit. But these strategies have some significant pitfalls. Anyone who turns to them should not only know what they can do for you, but also what they can do to you.
The biggest overall problem: Asset protection for asset protection’s sake is generally held to be illegal due to a concept called “fraudulent conveyance.”
The concept, in a nutshell, says you cannot give away your money to avoid a judgment or a creditor. But it is OK to give away your money for estate or tax planning reasons. The pivotal factor is intent.
Then, too, those with a lot of money and investments usually need to use several techniques to protect all of their assets. And each technique comes with pitfalls of its own.
Here are a few standard techniques:
* Irrevocable life insurance trusts allow you to transfer ownership of your life insurance policy to your kids or spouse. This is a good estate planning tool for anyone with a large insurance policy, because it takes the asset out of their estate and, if done right, avoids estate taxes. It also protects assets from creditors because the life insurance policy becomes someone else’s property.
The major pitfall: You cannot easily regain ownership of the policy if you change your mind about who you want to give the money to.
* Family limited partnerships work very much like regular limited partnerships, but they usually hold income-producing assets of a single family. They are frequently used to pass rental properties to kids and grandkids, which saves estate taxes. The other benefit is the parent retains control of the assets by serving as the general partner. Your creditors usually can get access only to income from your portion of the partnership. If you own 5% of the partnership, for example, they can only get the partnership distributions that relate to your 5%.
The disadvantages: They are exceptionally costly to set up and require maintenance. Initial set-up fees can range from $10,000 to $20,000, attorneys say. If you buy new rental properties and want to put them in the partnership, you usually need an attorney to help, at upward of $500 a crack.
Moreover, if you set them up improperly--or include inappropriate assets such as your home--you can jeopardize both the estate planning and asset protection functions and find yourself with income tax problems to boot. If you try to shelter your home in a family limited partnership, for example, you could hamper your ability to sell or refinance the home. And you could lose your home mortgage interest tax deductions.
* Homestead rules allow you to protect a portion of the equity in your home by filing a few papers with your state government. Homestead exemptions vary from state to state, however, and often do not protect all of the built-up value of a paid-off personal residence.
* Pension plans usually do not need separate asset protection; they are protected by the federal Employee Retirement Income Security Act (ERISA). There are some exceptions, for unusually large pensions and for pensions that you effectively control.
* Offshore asset protection trusts allow you to place cash and securities in the hands of an offshore trustee in any one of a dozen tax havens known for banking secrecy. The problems: You lose a tremendous amount of control over your assets; the strategy only works for assets that can be physically transferred offshore--such as cash, stocks, bonds and jewelry; they are expensive, costing at least a few thousand dollars, depending on what is going into the trust, and they may only delay your creditors rather than stymie them.
Anyone who is considering asset protection should consult an attorney who specializes in the field. This is a highly complicated and potentially treacherous area. The legal fees, which may cost more than $10,000, could be cheap in comparison to what you could lose if you do it wrong.
