Professionals, executives, entrepreneurs, and high-net-worth individuals are often concerned about the exposure of their assets to the claims of creditors. These claims can arise from numerous events, including accidents, professional liability, business dealings, or loan guarantees. In many cases, your unprotected assets may be at risk of seizure for payment to satisfy the debt.
Maintaining adequate insurance for various risks is always a good first step, but insurance policies do have limits in the types and amount of claims covered, and in some instances insurance may not be applicable. I often assist clients with asset protection planning to position their wealth in anticipation of these kinds of events. This does not involve hiding assets or making fraudulent transfers, but rather implementing recognized legal techniques in advance that help shield assets from the reach of judgment creditors in the future.
Forms of asset protection vary in complexity, administration, and cost (both legal and ongoing). Choosing the right types of protection given your situation and budget is important. Some different vehicles to protect against liabilities are as follows:
Business entities
Forming and operating your business as a corporation or limited liability company (LLC) can create a barrier between your personal assets and your business creditors. This “inside-out” protection can restrict liabilities for debts, judgments and losses of the company to the business itself and its assets. For “outside-in” protection (protecting the assets of the business from your personal liabilities) the use of LLCs and limited partnerships can help accomplish this result when other owners are involved. Generally, a LLC or limited partnership interest cannot be claimed by an owner’s personal creditors, nor can the creditor force the liquidation of the entity’s assets to satisfy the debt. The creditor can only obtain a charging order entitling the creditor to those profit distributions which are made to the owner. If no distributions are authorized or made from the LLC or limited partnership, the creditor may be stuck paying the tax on their proportionate share of income without actually receiving it. This can often lead to settlement of the debt.
Life Insurance
Many contracts of life or endowment insurance or annuities upon the life of a person, or any interest therein (excluding any amounts paid in fraud of creditors) are generally free from the claims of the creditors of such insured person.
Retirement and Education Savings Accounts
ERISA retirement plans (and benefit plans) such as 401(k), profit sharing and deferred compensation plans are subject to anti-alienation provisions, which prevent judgment creditors from attaching those assets and keep an employer or plan administrator from releasing your benefits to a creditor who attempts to collect from that plan. Contributions of a person to many types of IRAs that are less than or equal to the applicable limits on deductible contributions in the year when made are also exempt, as are similar contributions to 529 education plans. Note that while the amounts held in these plans are generally protected, they may be subject to attachment by creditors once they are distributed to you.
Trusts and Estate Planning
It is a common misconception that the use of a trust will automatically exempt its assets from the reach of creditors. This is not the case, particularly when the debtor is the creator and beneficiary of the trust. However, with proper planning, gifts made to family members and irrevocable trusts established by you for the benefit of your spouse and children can be structured to protect those assets from not only your creditors, but those of your spouse and children as well.
There are certain types of trusts that a person can establish in advance and remain a beneficiary of while removing those assets from the claims of creditors. Called asset protection trusts, they were once only available in foreign states and countries, often leading to increased complexity and costs of implementation, as well as more uncertainty in their administration.
However, Ohio has its own form of asset protection trust available, called a Legacy Trust. If properly formed and funded, the Ohio Legacy Trust Act generally provides that no creditor may bring any legal action of any kind to recover any of the assets held by the trust unless the creditor: (a) can prove that the transfer of the assets to the trust was made with the specific intent to defraud that creditor (e.g. if the creditor has a preexisting right to the assets transferred), and (b) the legal action is commenced no later than 18 months after the transfer of the property to the trust, or six months after the creditor knew or should have known of the transfer, whichever is earlier. The losing party in any such legal action is required to pay the legal costs of the prevailing party.
While the transferor/beneficiary cannot amend or revoke the trust, there are numerous rights he or she may retain, including the authority to receive all income from the trust, withdraw up to 5% of principal each year and receive discretionary distributions, remove and replace the trustee, reside in a home owned by the trust, and direct the investment of trust assets.