Asset protection is an increasingly important aspect of planning, however since so many planning related areas have begun to use the phrase, its definition has become less distinct. Some use “asset protection” to sell casualty insurance, lower risk investments, prenuptial agreements, wills and many more tangentially related areas. Our purpose is to conceptually cover what asset protection is and its practical applications.
At its core, asset protection is the use of legal entities, structures, and strategies to make assets difficult or impossible for a potential creditor to take. Asset protection planning often has strong estate planning benefits but does not involve a specific product, insurance, or tax schemes. The aim of planning is to mitigate the risk to family net worth from creditors, predators and divorce and works best when coordinated with a comprehensive wealth creation, preservation and transfer strategy.
Preserving net worth is not new and the topic is at the forefront of many family’s planning goals as litigation in the United States has dramatically expanded. Liability stems from areas where we may not have known an issue was developing. Some of the fastest growing segments of litigation are less obvious – social liability (parties, events, and guests), employment practices (discrimination, harassment, noncompliance), empowerment (actions which “aided” the actual wrongdoer), management (director, officer, advisor).
Many are left wondering how the court system and jury allow seemingly tenuous cases to produce seven figure judgments. Lawsuits typically follow asset ownership rather than actual wrongdoing as every plaintiff seeks “deep pockets” at the table. Asset protection aims to remove the deep pocket target and make one unattractive to a creditor.
Managing risk occurs before a claim is made. Asset protection is effective against future creditors and can be penetrated by an existing creditor one knows of or reasonably should have known of. Insulation can still often be achieved after the fact, but is limited in application and becomes significantly more complicated.
The most effective planning involves integration of overlapping areas that affect a family net worth; estate planning (incapacity, death disposition, reduction of probate, reduction of death taxes, guardianship, managing inheritances), tax planning (income tax shifting, maximum use of transfer credits, coordination of federal/state death taxes), business planning (exit strategy, key person retention, company structure, perpetuation), insurances (shifting risk, funding tax burdens), asset titling, entities, etc. to be arranged and implemented to coordinate in an easy to live with fashion.
Concepts that are familiar in investment planning are integral in asset protection as well; segregation and diversification. Few manage assets in one investment house or in one class of assets. Similarly, asset protection is not one technique or one entity; rather it is the use of combinations of strategies to achieve insulation, tax efficiency, and control.
The way we own and manage assets is directly related to the ability of a court and plaintiff to attach to them. Families often shift asset ownership to a spouse (who perhaps does not work, or has a lower risk profession), children, or other family members. In effect this is not reducing risk in as much as it shifts risk. The non-working spouse owning the home shifts the risk to the social events, household help, and guests of the home. There are still the car accidents, libel and other potential actions against that family member. If there is a difference of opinion, the asset earner does not have direct control, which often creates family rifts.
Corporations have been popular but serve a very limited purpose. The common perception is that corporate assets are insulated. To a large extent this is not the case. A corporation’s assets are fully reachable by a plaintiff with a claim against the corporation. A corporate entity is intended to shield shareholders from personal liability, however, many times the corporate veil can be pierced and personal liability attached.
Liability insurance is a common tool and a useful one. However, despite the many items the agent advises it covers, the list of risks it does not cover is far longer (i.e. divorce, employment practices, acts of adult children, intentional torts, business disputes). Diversification becomes apparent - liability coverage is a component – but should not be seen as the lone answer.
