Asset Protection: Is it Different than Estate Planning?

The Difference Between Estate Planning & Asset Protection

You may have heard the terms asset protection and estate planning but wondered if there is a difference between the two.  Many are familiar with estate planning, but asset protection can be somewhat of a mystery and oftentimes gets a bad name, evoking images of people engaged in criminal behavior to protect their money. Some wonder if asset protection is even legal. Is there anything that can be done to stop creditors from seizing all your property besides filing for bankruptcy? Financial planners and other business professionals often say it’s important to protect your assets and tell you that estate planning is essential but what does that really mean? Isn’t it the same as estate planning?  The answers are a bit more complicated than simply yes or no.

What is Asset Protection?

Asset protection, like the name implies, refers to the process of making sure that your assets (businesses, properties, stocks, bonds, etc…) are protected from creditors, seizure and other losses. In other words, it is guarding your wealth through specific legal strategies and forms of financial planning. More importantly, these tactics fall within the confines of the law. Asset protection helps to keep your assets safe legally without engaging in the hiding of assets(concealment), fraudulent transfers (1984 Uniform Fraudulent Transfer Act), tax evasion or bankruptcy fraud. The best time to begin the process of asset protection is before a lawsuit, claim, or liability arises. After a liability arises, it is usually too late to do engage in asset protection and may be considered fraud against the creditors. If you take action to engage in asset protection after liability arises, a creditor may be able to show that you as a debtor transferred the property in an attempt to hinder, delay or defraud the creditor. Therefore, it is imperative to take proactive and preventive measures for protecting your assets before you run into problems.

Asset Protection Strategies

Some common forms of asset protection include irrevocable trusts, limited liability company (LLC), family limited partnership (FLP) and insurance policies.

1. Irrevocable Trusts

A trust is a legal arrangement which allows a third party, the trustee, to manage assets on behalf of beneficiaries. The person who forms the trust is a called the settlor. The trust works by splitting up the interests of beneficiaries from their legal ownership. Beneficiaries are entitled to an interest in the assets in a trust but do not own legal title of it. The legal title belongs to the trustee, who is solely responsible for managing the assets in the trust for the benefit of the beneficiaries. A creditor’s ability to attach assets held in a trust are limited to those within the control of the debtor. Because of this, trusts as a form of asset protection, are often set up to give its beneficiaries the least amount of control over the assets in the trust. For example, under an irrevocable trust, the settlor must give up control and ownership of all property within this trust.  If drafted correctly, a trust is a good way to protect your assets from creditors, judgments, and lawsuits. It can even induce settlement negotiations or deter potential creditors from initiating expensive litigation in the first place. However, even an irrevocable trust is generally not immune from certain claims like child support, alimony, and federal and state tax claims. These trusts are still subject to judgments of US courts, including claims of fraudulent transfers.

Irrevocable trusts generally protect assets that are transferred for the benefit of a person other than the settlor (creator).  However, in California and  most other states, an irrevocable trust created where the settlor is the beneficiary will not necessarily serve as a viable asset protection strategy. Such a trust is considered a “self-settled trust” where the settlor retains rights as a beneficiary. But 17 states currently allow for self-settled trusts (also known as “asset protection trusts”). Where permitted, self-settled trusts enable you to protect your assets rather than just the assets of a separate beneficiary.

A foreign asset protection trust, otherwise known as an offshore trust, are held in accounts outside the U.S. in places like Cook Islands and the British Virgin Islands. These trusts are often more expensive but often provide the most protection to California residents because they permit self-settled trusts. Foreign judgments are not recognized by the foreign courts and often have shorter statutes of limitation. The process for attacking assets held in offshore trusts proves to be much harder with creditors having to travel to the foreign jurisdiction and then initiate the process again within California.

2. Limited Liability Companies and Family Limited Partnerships

A Limited Liability Company (LLC) and Family Liability Partnership (FLP) are other tools used in asset protection. Ownership of property can be transferred into either entity to safeguard against potential creditors, lawsuits and extra capital gain taxes. An FLP has the added benefit of allowing members and their spouses to own a small portion of the partnership while still controlling the entire partnership and its assets. Corporations are another option to protect assets, but there are circumstances where a creditor may “pierce the corporate veil”, which allows them to seize the assets of a corporation. In addition, stocks in a corporation are not secure from the reach of creditors. Creditors can attach a shareholder’s stock and then gain access and control of the company. LLC’s and FLP’s are more useful because it is harder to pierce the corporate veil for these entities so long as they are set up properly and there is no commingling of personal assets. These entities can also help to reduce estate and income taxes. In many cases, we recommend the formation of entities in states other than California that have more favorable laws for protection against creditor claims.