Financial advisory clients are routinely concerned about lurking threats to their hard-earned wealth in the form of a large unforeseen judgment on a liability claim. While asset protection is a popular planning topic for High-Net-Worth (HNW) and ultra-high-net-worth clients, those who are not HNW are susceptible to the same threats to wealth. However, while some protection options come with a high cost (that might not be practical for non-HNW clients), asset protection can come in many forms, some of which do not involve excessive fees or complexity. Which means that by taking into account a client's net worth, realistic liability risks, and level of sophistication, advisors can help assess what types of strategies may be appropriate for the client to explore.
Notably, certain client assets have built-in creditor protection without the use of (often expensive) products or tools. For instance, qualified plan assets (e.g., 401(k) and 403(b) plans) offer purportedly unlimited creditor protection for plan participants, meaning that if an individual were to be sued or file for Federal bankruptcy protection, balances in these accounts would not be at risk. However, these benefits do not automatically extend to other types of retirement accounts (such as IRAs), the protection for which varies by state. Other sources of (often) built-in protection include homestead protection for a primary residence (some exemption is offered by most states, though not always automatically in place) and the benefits of joint account ownership (e.g., tenancy by the entireties and community property).
For other assets, insurance can represent the first line of defense against liability for a client, with other tools to fill in the remaining gaps, insulate assets from each other, and protect against any judgments that exceed coverage limits. For instance, an umbrella insurance policy can be an effective way to protect against significant personal liability claims in excess of any existing coverage the client possesses. Beyond insurance, advisors and their clients can also consider options such as the use of corporate entities such as Limited Liability Companies (LLCs) for business interests, and estate tax planning tools such as Spousal Lifetime Access Trusts (SLATs) that can offer both estate planning and asset protection benefits for married couples.
In addition to helping clients identify which assets might already have creditor protection and selecting the tools and products that could help protect other assets, advisors can play an important role in ensuring that asset protection plans do not run afoul of the law or are not subject to reversal. For instance, because most states have adopted the Uniform Fraudulent Transfers Act (UFTA), any transfers made less than 4 years prior to a creditor claim in those states may be reversed, which means that if a client gives something away (or transfers it for less than fair market value) with the intent to 'outsmart' creditors by transferring or hiding assets, then a judge can order the transfer undone and the asset returned to be used to cover the creditor claim (assuming the claim is made less than 4 years after the transfer).
Ultimately, the key point is that financial advisors can play an important role in helping their clients protect their assets, both in terms of educating clients on the protections they currently have and the options available to protect other assets, as well as in helping them avoid pitfalls that could put their asset protection plan at risk. Which means that knowing how to use the pantheon of strategies and understanding existing laws can help an advisor provide clients with the highest and best asset protection for the peace of mind their clients seek!
In a litigious society, individuals are routinely concerned about lurking threats to their hard-earned wealth in the form of a large unforeseen judgment on a liability claim. While asset protection is a popular planning topic for High-Net-Worth (HNW) and ultra-high-net-worth clients, those who are not HNW are susceptible to the same threats to wealth. However, their realistic protection options are more limited due to practicality and cost. That is certainly not to say there are no options. Asset protection can come in many forms and can include many traditional financial planning techniques advisors are accustomed to using, maybe just not in the context of asset protection.
Even though many traditional asset protection techniques are implemented by clients' attorneys, advisors can still play a critical role in helping ensure a client's portfolio is protected. Additionally, some of the most effective asset protection tools do not require excess fees and complexity at all but, rather, already exist in the law; a savvy advisor can help a client maximize those protections while not substantially impacting their ability to enjoy their wealth.
The asset protection discussion can be seen as a 'continuum' with the client having full control of their assets and little to no asset protection on one end, or no control (i.e., they have given away the asset) and significant asset protection on the other end. Regardless of a client's level of net worth, advisors are in a great position to help them identify their best place on the continuum and the steps needed to get there, given the client's specific situation and concerns.
Asset Protection Tools For (Not-So) High-Net-Worth (HNW) Clients
While HNW clients have access to a variety of tools that can be used to achieve asset protection, many of the popular tools are often not typically prudent for individuals who are not HNW. Most clients cannot lock up a large proportion of their wealth in a vehicle where it is not freely accessible. Due to the complexity of these strategies, the initial cost of setting up a complex plan such as a Domestic Asset Protection Trust (DAPT) or offshore trust can be high, as they require coordination with multiple professionals, likely with substantial hourly rates. Additionally, the administration of these trusts (usually in jurisdictions other than the client's domicile) can be costly and time consuming.
Therefore, the cost/benefit analysis performed for any client other than a HNW one (even when they have high asset protection priorities) would likely not result in implementing one of these strategies. And when these clients turn to their advisors for guidance on what asset protection measures may be prudent, many advisors find themselves at a loss for sound recommendations that make sense financially for their clients. However, there are several options for non-HNW clients who are concerned about protecting their assets. Taking into account their net worth, realistic liability risks, and level of sophistication, advisors can help assess what types of strategies may be appropriate for the client to explore.
How Entities Can Provide Corporate Asset Protection
The use of corporate entities is a bedrock of asset protection. Placing assets into an entity, most commonly a Limited Liability Company (LLC), can effectively sever the personal liability of an owner from liabilities associated with the entity. Interestingly, putting assets in an LLC also can provide protection for the assets in the LLC against liability claims levied upon the individual. This can be referred to as "inside" and "outside" liability protection.
For example, if a client has a rental property owned within an LLC and there is a lawsuit resulting from a slip and fall at the property, the Plaintiff's only recourse for collection would be from the assets of the LLC that owned the property. That is called "inside" protection.
If the LLC owns multiple properties, then the liability associated with one property could affect the other properties within the same LLC. If each property were in its own LLC, though, they would each be insulated from claims against the other.
On the flip side, if a person were to be sued individually, their personal assets would be at risk. But if the person also owned a membership interest in an LLC, while the membership interests in the LLC would be considered assets of the individual, the only recourse the creditor would have would be to seek a "charging order" against the LLC.
A charging order is a direction given by a judge who determines that any future distributions from the LLC to the individual should be directed to the creditor instead. Ostensibly, many charging orders are worthless because the client affirmatively elects not to make future distributions from the LLC. This is called "outside" protection.
LLCs are usually a good tool for protection when the asset it owns carries with it some liability concern (i.e., rental real estate and tenant/guest injury risks). However, establishing an LLC purely to own a personal investment portfolio would rarely make sense. It would take an odd set of circumstances to fathom a liability risk related to the ownership of stocks and bonds, and, therefore, an LLC would offer minimal 'inside protection' value. The charging order' outside protection' for the investment portfolio would rarely, by itself, justify such a strategy, especially taking into account the cost to establish and maintain the LLC (i.e., annual fees to the state and additional tax filings).
Piercing The Corporate Veil
As foolproof as this strategy seems, there are still ways a creditor can get through the shield the entity provides by having a Judge make a determination that the entity is just 'smoke and mirrors'. This is called "piercing the corporate veil". A creditor can pierce the corporate veil and successfully argue that an entity should not shield an owner from personal liability in the following different ways (this list is not necessarily exhaustive as courts will have wide discretion to determine the appropriate facts to warrant personal liability):
- The business failed to adhere to corporate formalities. This means the business wasn't run like a business in accordance with state law. Perhaps they didn't keep sufficient corporate records, meeting minutes, etc.
- The owner used the business simply as an alter ego of themselves. For example, depositing payments from renters of real estate owned by the LLC directly into their personal bank account, or otherwise commingling company assets with personal assets.
- The business had no valid business purpose. This is not a requirement in every state, but some require that a business registered in their state detail the business purpose when forming an entity. So, let's say an individual owned a vacation property and wanted to bolster protection for it. They form an LLC and detail on the organization paperwork for the state that they intend to "own and operate rental real estate" but never actually rent the property. Clear intent to create an entity without a legitimate business purpose could be problematic in a creditor claim.
- Misconduct. Perhaps the most common argument in favor of an individual being liable for debts of the entity involves an owner engaged in serious misconduct , such as using the entity to perpetrate fraud (e.g., misstating the value of business assets to secure a loan).
It is sometimes helpful to think of entity-provided asset protection as comparable to walnuts. Taking cost out of it, when buying walnuts, many people find it more convenient to get the shelled walnut (i.e., those without a shell) versus the unshelled walnuts that still have the shell on them. Why? Because it is far less work to eat the walnuts when you don't need to remove the shell. There may be a way to open the shell and get to the nut, but the time and energy involved is a deterrent to buying them.
A creditor may have a similar mindset when it comes to assets held in an entity. A creditor is far less likely to seek execution on an asset inside an entity that the individual owns rather than in an individual's name alone due to the time, effort, and expense involved.
It is important to consider the number of members of a company when assessing how strong the protection could be. A single-member LLC may not be recognized as a shield from liability in some states, as the court would see the company and individual as one because of the unilateral control the individual has. One strategy that is sometimes effective in combating this issue is to have another individual, perhaps a spouse, as a small percentage owner (e.g., 1%) in order to justify the protective nature of the entity.
How Trusts Can Protect Assets For Married Couples
An effective tool for a married couple to achieve creditor protection could be the use of a trust, such as a Spousal Lifetime Access Trust (SLAT). With a SLAT, the grantor makes an irrevocable gift to the trust, but provides their beneficiary spouse with access to the assets of the trust for their lifetime.
SLATs are primarily seen as an estate tax planning technique to remove assets (and the growth thereon) from a grantor's estate, but can offer asset protection benefits as well. When a SLAT is funded, the grantor relinquishes control of the assets. The grantor's spouse could be named as beneficiary (and even trustee), and the assets could only be distributed at the trustee's discretion. Discretion may be limited to health, education, maintenance, and support if the spouse is serving as trustee.
Because the grantor no longer owns or controls the asset, the grantor would be insulated from liability. The trust would contain a 'spendthrift clause' that prohibits any beneficiary from transferring their interest, thereby shutting out a creditor's rights to access the trust funds – even if it is the spouse-beneficiary's liability.
There are a couple of considerations before jumping into a SLAT solely for asset protection reasons:
- Because the assets are removed from the grantor's estate, there would not be a step-up in basis on the death of the grantor. (If removing assets from the estate is not a priority, then there may be a simpler option between spouses that does not require the use of a trust, to be discussed later.)
- The grantor is relinquishing control of the asset, so if the spouse dies or there is marital discord or a divorce, this could result in the grantor losing the value of the assets in the trust.
Although the use of entities and trusts are popular tools to bolster creditor protection, there may be another option that achieves similar protection without the added administrative complexity or loss of control – purchasing insurance. Insurance can represent the first line of defense against liability for a client, with other tools to fill in the remaining gaps, insulate assets from each other, and protect against any judgments that exceed coverage limits.
One core principle taught in law school is that you are always responsible for your own negligence. Therefore, even if an entity is used as a wrapper around an asset for liability protection and if the owner themselves commits an act of negligence that results in a lawsuit, that individual can still be held personally liable.
For example, let's say a client owns a membership interest in an LLC that owns a rental property. The client decided to save some money on improvements and installed a pendant light on their own for a tenant space. The electrical system was not wired properly and caused a fire that damaged the tenant's property. Although the 'injury' occurred on a property within the LLC, the client themselves acted negligently installing the light, and, therefore, both the LLC and the client could be pursued for damages.
Insurance would be an effective tool to offer protection for this scenario. In fact, there may be scenarios where the client does not need an asset protection tool at all and should feel safe with insurance coverage alone.
An umbrella insurance policy can be an effective way to protect against significant personal liability claims in excess of any existing coverage the client possesses. This coverage would be designed to supplement home and automobile insurance (in fact, an umbrella policy would likely require that sufficient home and auto policy coverage be in place prior to payment from umbrella coverage).
It is important that the client's net worth, identifiable liability risks, and existing coverage are all carefully considered to determine the appropriate coverage. While a person can never have too much coverage, the premium cost must match the benefit it offers. However, the higher the net worth, the more potential risk there can be. It may not be necessary to have a policy limit that covers the entire net worth of the client, but there are certainly instances where a personal liability litigation award could get into the millions, so a proper investment in substantial coverage could provide peace of mind.
How Advisors Can Educate Clients On Asset Protection Rules
While there are various products and tools available to provide (or at least enhance) creditor protection, all of those items cost something and, in most cases, require a professional other than an advisor to help implement. Therefore, as important as it is to know what asset protection products and tools are available for a client to expend resources to employ, it is even more important to know what protections are inherent in the law. Clients' concerns over asset protection can be alleviated by educating them about how the assets they have may already be statutorily protected without the necessity of complex planning.
Retirement Accounts Protected By ERISA Rules
Retirement accounts can represent a significant part of a client's total net worth, so they may be very interested to know the exposure their nest egg could have to looming threats. Transferring these types of accounts into an entity or trust with asset-protection benefits during the accountholder's life is not possible without losing tax-deferred growth. This is because accounts must be owned by the individual who contributed the funds (hence why the term "individual" is the first word in most of these account types). Therefore, most clients will need to rely on the protective nature of the law as it relates to retirement funds.
Qualified plan assets, such as 401(k) and 403(b) plans, are implemented and administered under the rules of the Employee Retirement Income Security Act of 1974 (ERISA). Such employer-sponsored plans offer purportedly unlimited creditor protection for plan participants. That means if an individual employee with a large 401(k) plan balance were to be sued or file for Federal bankruptcy protection, no amount of the account balance would be at risk. However, this powerful level of protection does not necessarily extend to other types of retirement accounts.
Individual Retirement Arrangements (IRAs) are not protected by Federal ERISA rules. Instead, to determine their protections, it is necessary to refer to individual state law. Many states offer extensive, sometimes unlimited, protections for IRAs. However, other states limit protection of an IRA to the amount necessary for the support of the debtor and have various exceptions to protection of the account in bankruptcy if the debtor is subject to a spousal or child support claim.
Spouses who are recipients of funds as a result of a divorce decree or Qualified Domestic Relations Order (QDRO) should retain all of the same protections offered to the original contributor themselves. This is also true for inherited funds that the surviving spouse treats as their own through a spousal rollover.
However, in some cases, an IRA is only an IRA in name when it comes to statutory creditor protection if the original source of the funds was a qualified retirement plan. This is often because the ERISA protections offered to the qualified plan assets are not extinguished upon rollover to an IRA, but instead the protections could 'roll with' the funds to the IRA.
While qualified funds rolled to an IRA enjoy unlimited protection in Federal Bankruptcy, state creditor protection may be less clear. The extent of protection extended to these rollover IRAs will depend on the state court's interpretation. For example, the state with perhaps the weakest creditor protections for IRAs, California, has case law supporting the position that unlimited protection extends to an IRA if the original source of the funds was an ERISA plan.
Therefore, while it is critical for advisors to know the types of retirement accounts a client has, it is just as important to know the original source of the contributed funds when assessing the available protections.
While commingling both regular IRA contributions and qualified plan rollover funds in one IRA does not necessarily eliminate the ERISA protections for the rollover portion of the account, it does make accounting for 'what funds are what' much more complex. Absent a good system to make each source of funds readily identifiable, one best practice could be to segregate funds originally contributed to qualified plans from accounts funded through traditional IRA contributions. For example, a dedicated "qualified plan rollover IRA" could be maintained that is separate from an IRA account to which annual contributions are made.
Additionally, there could be an opportunity to give an IRA with limited state protection limitless protection by rolling the IRA funds into a qualified retirement plan such as a 401(k) or 403(b) plan. This strategy is dependent on whether the client has access to a qualified plan that will accept an incoming rollover, and if they do, such a rollover could enhance the protection of their funds. As an added bonus, this could also delay the commencement of Required Minimum Distributions (RMDs) if the client is still working, as RMDs taken from qualified workplace retirement plans (e.g., 401(k) plans) can be delayed indefinitely until retirement. By contrast, RMDs from traditional IRAs are required to be taken by age 73 (beginning January 1, 2023) and by age 75 (beginning January 1, 2033).
It is important to note that as a result of the Supreme Court's 2014 decision in Clark v. Rameker, inherited IRAs are not considered "retirement accounts" for the purposes of bankruptcy. The prevailing presumption as a result of this ruling (even beyond bankruptcy) is that inherited IRAs should be considered similarly to an individual brokerage account when it comes to creditor risk.
Homestead Exemptions Can Offer Some Statutory Protection Of Primary Residences
A client's home often represents their most cherished asset, both financially and emotionally. Therefore, its protection can be of the utmost importance. Certainly, insurance and trusts can offer peace of mind, but, depending on the client's state of residency, they may also have statutory protection of their equity from creditors.
Most (but not all) states offer some exemption for an individual or spousal couple's equity in their primary residence from creditors in the form of statutory homestead protection. The limits vary wildly depending on the state of residency (New Jersey and Pennsylvania offer no protection), so it is important for the client to know their particular state's exemption in order to determine what asset protection tools are necessary, if any, to supplement the homestead exemption and protect their home's equity. This could also be a factor in deciding the appropriate state residency of a client if they have a choice (think 'snowbirds').
Often confused are a 'homestead exemption' for tax purposes and a 'homestead exemption' for creditor protection purposes. Many states offer a real estate tax break for those who use and occupy a property as a primary residence. While eligibility for each may go hand in hand in some states, they are different concepts.
It is important to note that the resident sometimes must adhere to formalities in the law to maximize the protection offered through their state's particular homestead exemption provisions. Some states' homestead protections are not automatic and require an affirmative filing with the local government to obtain the maximum protection by law. Massachusetts, for example, takes a hybrid approach where a resident receives $125,000 in protection for the equity in their home automatically, but that protection soars to $500,000 with the simple filing of a form.
It is also critical that the client take appropriate action to establish residency in the preferred state of protection. You can only have one primary residence and, therefore, cannot claim homestead protection in multiple states for multiple personal use properties. Furthermore, establishing residency has rules that vary by state, involving a time component (i.e., physically residing in the state for a set number of days) and also an intent component, which is less objective.
If a client has a preferred state of residency, then they should take all reasonable steps to show they live in that state. This means registering to vote, registering vehicles, filing a declaration of residency (if available), etc. There is no one set of standards that would guarantee that a person will be deemed a resident of that state for homestead and tax purposes, but the more indicia that they intended it to be so will support their cause.
Homestead protection would not protect a homeowner from the foreclosure of their mortgage. Homestead statutes are designed to prevent non-consensual creditor claims from resulting in the loss of their place to live. By contrast, a mortgage is a contractual consensual lien voluntarily granted by the homeowner.
Benefits Of Joint Account Ownership
The way a client elects to own property can greatly affect whether a creditor may reach it, especially when ownership is between spouses. An individual who has been ordered by a Court to pay a sum of money as a result of an unfavorable judgment (a judgment debtor) is in a vulnerable position. A judgment debtor's individual ownership of an asset is just that, wholly individually owned, so it will not carry many protective qualities by itself. Joint ownership can, however, be helpful in certain circumstances, depending on the available registrations and the relationship of the owning parties.
Some of the different types of joint account registrations and their protective qualities (or deficiencies) are discussed below.
Tenants In Common And Joint Tenancy
Tenants in common and joint tenancy are forms of ownership where multiple parties may own an interest in a single account or asset. In joint tenancy, if one owner dies, then the remaining owners automatically inherit the decedent's share of the asset, whereas, with tenants-in-common, the deceased owner's interest will pass via their estate.
Such forms of ownership offer minimal creditor protection compared with any other available joint ownership structure because creditors may freely seek access to the debtor's ownership interest in the account as if they owned it individually. The creditor cannot generally, however, go after any interest in excess of the debtor's ownership interest in the account. This may require an analysis of contributions to determine the respective ownerships of the parties.
Tenancy By The Entireties
Tenancy by the entireties is a form of joint ownership that may only be held between spouses and is available in some states. It is essentially a stronger form of joint tenancy. With a tenancy by the entireties registration, neither spouse may dispose of their interest in the property without the consent and participation of the other owner. This feature means that creditors are unable to legally force the liquidation of a tenancy-by-the-entireties asset for a claim against just one of the spouses. Not all states permit tenancy by the entireties, and some that do, only permit tenancy by the entireties for real estate ownership. However, where available, this form of ownership can be a powerful creditor deterrent.
It is important to verify whether an unmarried couple with joint tenancy or tenants in common property who gets married would prefer a tenancy by the entireties form of ownership, as it is not necessarily an automatic conversion upon marriage. It may be the case that a new account needs to be established or the deed updated on real property.
Community property is a special form of ownership available to spouses in a select few states. Under community property, a creditor can reach the entire asset, even if only one spouse is the debtor. Therefore, it could be advantageous for a creditor-conscious couple to sever their community property interest through a community property agreement to ensure each spouse's debts do not infringe on each other's property interests. Such a decision needs to be arrived at carefully, considering the benefits relinquished (especially a full step-up in basis on the death of one spouse).
Alaska, Florida, Kentucky, and Tennessee have enacted 'elective community property' statutes, whereby residents may affirmatively elect certain property to be treated as community property. There is significant concern as to whether these laws will be respected by the Internal Revenue Service (they refused to address these states in IRS Publication 555 on Community Property) and whether they would withstand legal scrutiny, as the Supreme Court has previously denied the legality of a similar Oklahoma statute.
Shifting Ownership To Deal With Liability Risk
As discussed with the Spousal Lifetime Access Trust (SLAT) earlier, getting an asset out of one spouse's name can be an effective asset protection technique. The good news is that clients may not even need a trust to do this. Other than community property, simply putting assets into the sole ownership of a spouse can insulate the assets from creditors. This is an especially popular planning approach when one spouse is engaged in a much riskier profession than their spouse (e.g., a surgeon).
There are some risks to this asset protection technique, however, and it should not be done when the concerning liability is already known or imminently impending (as we will discuss later in regards to fraudulent conveyances).
The major concerns with this approach relate to the relationship between the spouses. What if there is a divorce? What if there are control concerns? What if the spouse ends up with their own creditor issues? Once the 'risky' spouse transfers the assets, they can no longer control what may happen down the line, which could eventually result in the loss of some or all of the asset – the very thing they were looking to protect against!
Creditor Protection At Death
Clients often die with outstanding liabilities and creditors who would very much like to be repaid. When a probate estate is administered, creditors may need to be notified in accordance with state law and can lay claim to payments from the estate (at a priority higher than beneficiaries!). A creditor can even sue an estate for a liability of the decedent that they had not yet commenced action on during the decedent's lifetime.
Many of these issues can be avoided by ensuring that assets pass outside of the probate process. This means ensuring the client titles non-qualified assets in joint tenancy, Transfer On Death (TOD) designations, and/or ownership titled in a revocable trust. Of course, for retirement accounts, this just means naming a beneficiary (as long as they are not naming the estate!).
Creditors may still technically have an avenue of recovery for non-probate assets from named beneficiaries. Many states have statutes authorizing such action for recovery of claims against the decedent. However, whereas the probate process is public and the creditor has access to all kinds of information on the value of the estate and the proposed beneficiaries, they do not generally have access to much information for the assets transferred outside of probate. Therefore, the time, resources, and effort necessary to try to collect means that it is rare that a creditor will successfully pursue beneficiaries to satisfy claims against the decedent.
Pitfalls To Avoid
An important part of an asset protection plan is identifying when a client may be running afoul of the law and digging themselves a hole. Advisors should always make sure to assess the 'why' of large gifts and account ownership change requests. Clients would be wise to tread lightly when their do-it-yourself asset protection ideas come to mind. Often, clients under extreme stress will think they can 'outsmart' creditors or the government by transferring assets or hiding them. This can create disastrous results and can sometimes even be criminal.
Most states have adopted the Uniform Fraudulent Transfers Act (UFTA), which states that any transfers made less than 4 years prior to a creditor claim may be reversed. The burden of proof is tough to overcome. That means if a client gives something away (or transfers it for less than fair market value) with an idea that there may be a claim against them coming, then a judge can order the transfer undone and the asset returned.
A key component to assessing whether a fraudulent conveyance occurred is looking at whether there were any "badges of fraud" under the UFTA. As summarized by the American Bankruptcy Institute Journal, these include the following "conditions or events that are suggestive of fraudulent intent":
- the transfer or obligation was to an insider;
- the debtor retained possession or control of the property transferred after the transfer;
- the transfer or obligation was disclosed or concealed;
- before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit;
- the transfer was of substantially all the debtor's assets;
- the debtor absconded;
- the debtor removed or concealed assets;
- the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred;
- the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred;
- the transfer occurred shortly before or shortly after a substantial debt was incurred; and
- the debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.
A fraudulent conveyance can even apply to the spousal transfers discussed earlier, such as to SLATs or the spouse's name! Transferring assets to non-spouses (like children) is particularly dangerous.
Putting assets in children's names is a common example of 'do-it-yourself' asset protection. However, the pitfalls are boundless.
When you transfer assets to another person, you are subjecting those assets to whatever is going on with that person. Let's lay out the readily conceivable concerns:
- There will be a loss of a step-up in basis at death;
- Assets could be subject to division in a divorce proceeding;
- The child could develop into a spendthrift or gambler, or they could have a substance abuse issue;
- [insert bad scenario].
It is not always required that it be shown that the transfer was done intentionally or with malicious intent. As an example, let's say a mother designates her son as a joint tenant owner of her house and tells him to "split this with your brother when I die" rather than passing the property through her will or trust.
Well, unfortunately, mom passes away, son inherits, and son sells the property, splitting the proceeds as he was directed. The problem? Son is in serious debt, it spirals, and he needs to file for bankruptcy 2 years later. Unfortunately, due to the UFTA, the bankruptcy trustee (or a creditor in a lawsuit) is going to have the ability to demand the return of the assets 'gifted' (technically) to his sibling to help satisfy the remaining creditor claims.
It is a severe result, but it highlights the reason clients should be very careful and consult their advisor prior to any major gift. Of course, in addition to any possible creditor issues, they should also be aware of potential gift reporting requirements.
Asset protection can be a difficult topic for clients because it can be a product of anxiety rather than a realistic possibility. However, even though most clients will never actually endure the concerns about liability they have in their minds, it does still represent a risk that can be alleviated either through education or asset protection tools. Knowing the pantheon of strategies and existing laws can help an advisor provide clients with the highest and best asset protection for the peace of mind they seek.
This material is intended for informational/educational purposes only and should not be construed as tax, legal or investment advice. Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Please consult with your financial professional and/or a legal or tax professional regarding your specific situation and before making any investing decisions.