Most of us have at one time or another worried about causing an accident and being sued. Or considered the financial loss that might result from a divorce or bad business dealing. These are just a few situations in which your personal assets may be taken by creditors, whether an injured person, a divorcing spouse, or a bank.
Many people believe if they are sued they can give their money away, or move assets “offshore.” In reality, neither of those options are sustainable.
In this blog, I’m going to share my 25 years of experience helping my clients arrange their affairs so that if the unexpected happens their assets are protected to the fullest extent possible.
What is asset protection?
What asset protection planning is really about is legally reorganizing the ownership of your assets well in advance of any potential problem so that your and your family’s creditors cannot legally reach them.
In asset protection planning we utilize various laws in the same way as tax planning strategies utilize the tax code. If you plan properly the assets you have spent your life accumulating will be protected should you or your family be faced with an economic crisis or a serious lawsuit.
If you are concerned about protecting your assets for yourself, your family members, and future generations, you need to know your options and you need to plan sooner rather than later.
Can’t I Just Give Away my Assets?
Oftentimes when faced with a lawsuit or other financial crisis a person will give away their assets to a close friend or family member. The flawed idea is that if you don’t own the assets your creditors can’t reach them. In fact, arbitrarily giving assets away when you are faced with a problem is the worst thing you can do.
The MichiganUniform Voidable Transactions Act (UVTA) empowers creditors to reach assets that have been given away. However, with careful planning and a complete understanding of the UVTA, ownership of your assets may be changed to make it more difficult for creditors to take them, if not impossible.
Assets that are Protected By Law
Your Retirement Accounts (401k and IRA)
Knowing the types of assets that are automatically protected is important. For example, your 401(k) is protected from creditors. IRAs are also protected, but certain limits apply. This protection applies even if you file for bankruptcy. However, if you inherit an IRA from someone other than your spouse it is not protected.
Your Personal Residence
Most State laws also protect a person’s residence (known as the “homestead exemption”). In many States the homestead exemption is meaninglessly small, including Michigan. But if you have a home in, say, Florida or Texas, you can protect millions of dollars.
If you co-own real estate with others, your creditors will have a difficult time getting paid – but in most cases they can go to Court and force the sale of the property to collect.
If you are married and own real estate jointly with your spouse, then the creditor of one spouse cannot reach the property under any circumstances.
However, if a married couple deeds their real estate to a revocable trust, or they add the name of a child to the title, this special protection is lost.
Certain states, including Florida, Texas and Michigan, provide annuities, including private annuity, with significant protections from creditors. The decision to obtain an annuity should always be driven by reasons other than asset protection. If the circumstances under which an annuity is obtained is suspect, you will lose the protection that may otherwise be available.
For those assets of yours that are not automatically protected, you have other options but in order to be protected, you have to take action.
Michigan Asset Protection Trusts
Revocable Living Trusts have many advantages, and they can protect an inheritance you may leave after your death for your family and other heirs. But an ordinary revocable trust does not protect your assets during your lifetime.
On December 5, 2016 Michigan adopted a law specifically designed to permit anyone to transfer some or all of their money and property to an Irrevocable Trust that can protect their assets from future creditors during their lifetime while still retaining benefits from the Trust assets. Sometimes these types of trusts are called “Domestic Asset Protection Trusts,” or DAPTs for short.
A Michigan Asset Protection Trust is very different from your typical Revocable Living Trust. You cannot be the Trustee, you cannot change the terms of the Trust (that is, you cannot amend the trust), and there are other limits and technicalities.
But you can appoint family members or a professional (your attorney or accountant) to serve as your Trustee provided they are Michigan residents. You can remove the Trustee for any reason and appoint someone else, so in a sense you have some control over the Michigan DAPT. You may also direct investments, veto distributions, and receive income from the Michigan DAPT.
A Michigan DAPTs may work in conjunction with an ordinary revocable trust to give you a level of security not otherwise previously available in Michigan. If you have any questions about incorporating an MAPT into your estate plan, please contact us anytime.
Separate Baskets for Each Egg
The ownership of property, whether it is real estate, a business or a motor vehicle, may give rise to a lawsuit. Containment involves arranging the ownership of your property to separate your personal assets from the potential liability.
If you own rental real estate in your individual name you may be personally liable if someone is injured on the property. But if your real estate is owned by an LLC, your personal assets will be protected. It may also be a good idea to have a carefully drafted lease agreement with your tenants, shifting to them certain responsibilities to maintain the property.
If you allow another person to drive your vehicle and they cause an accident, you will be liable for the driver’s negligence even if you were not driving. Liability arises from the mere fact of ownership. So, you should be careful in allowing others to drive your vehicle, and generally spouses should drive their own cars. Never have joint names on the motor vehicle title as this will subject both joint owners to liability.
If you are a business owner, your personal assets may also be at risk of loss if an employee causes an accident, or you sign a business contract and the arrangement does not turn out as expected. We generally recommend having a separate business entity (whether an LLC or Corporation) for any business activity. It may also make sense to place real estate, motor vehicles or equipment used in a business in separate entities. By using separate entities you avoid having “all your eggs in one basket.”
There is a common misconception that if you place your property into a revocable trust that creditors cannot reach them. That’s simply not true. During your lifetime your revocable living trust provides no protection from your creditors. However, if drafted properly your revocable trust may protect your heir’s inheritance after you have passed away. If you are concerned about a beneficiary becoming divorced or getting involved in a bad business deal, or if he or she is very young or simply has poor financial judgment, you’ll need special provisions in your revocable trust agreement.
In order to protect a beneficiary’s inheritance the beneficiary cannot have the right to compel distributions from the trust. Instead, an independent trustee must have complete discretion over the trust fund. When an independent trustee has complete control, no one, including the beneficiary or a creditor of the beneficiary, can tell the trustee what to do with the trust fund. With the beneficiary having no ascertainable right to demand the trust fund, and an independent trustee in the driver’s seat, creditors simply have no way to access the trust fund, even if the beneficiary files for bankruptcy.
Even with good asset protection planning you need insurance. You should also have an “umbrella policy” that covers you for claims that exceed the basic limits of your insurance. Having extensive insurance for your real estate, business and motor vehicles is critical and cost-effective, and we highly recommend having extensive coverage at all times.
Limited Liability Company
To form an LLC you must register with the State. After registration, you may transfer cash, investments or other property into the LLC. The LLC will then issue you shares representing your ownership (similar to shares of stock in the stock market). If you transfer assets into an LLC, the assets are protected from your creditors.
By law, creditors may not reach the assets within the LLC. A creditor may only obtain a “charging order” against your shares. The charging order will entitle your creditors to any distributions that may be made from the LLC. So, as long as no money or property is distributed from the LLC the creditor receives nothing. The fact that creditors are only able to obtain a charging order against an LLC means a creditor is likely to settle for less, as opposed to wait around to see when and if a distribution from the LLC is made.
Although LLCs are not “bullet proof” against creditors, they do afford a level of protection that is appealing, especially given the ease in which an LLC may be established, the flexibility the tax laws afford them and the fact that contributions to an LLC avoids the UFTA.
Asset protection planning is commonly associated with offshore trusts, often located in exotic places among the Caribbean Islands. All offshore jurisdictions offer essentially the same thing: U.S. creditors cannot enforce their U.S. judgments (claims) in the offshore Courts. This means that assets held in these jurisdictions are practically, and to an extent technically, unreachable. Although U.S. Courts do not have jurisdiction over trust assets that are offshore, U.S. Courts do have jurisdiction over the physical person who owes money (the debtor) and can throw him or her in jail for contempt if there is a refusal to bring the assets back (“repatriate” them) to the U.S. So, for offshore planning to work the debtor must either physically remove him or herself from the United States, or appoint a foreign trust bank to serve as trustee with complete control over the funds.
Many offshore trust banks are inadequately capitalized and lack meaningful regulation. However, there are jurisdictions and banks that are fundamentally sound. If you choose to transfer funds offshore, choosing the right jurisdiction and a trust bank is critical. Using an offshore trust is generally reserved for emergency situations in which a debtor is willing to take extraordinary actions to preserve extensive personal assets.
If you have concerns about losing your personal assets to a lawsuit or other creditors, or you want to protect your heirs from potential future loss, you need to know your options. While you can’t just give away your assets, there are ways to minimize risk. The law provides automatic protection for certain assets, and taking advantage of that protection (and making sure you do not accidentally lose that protection) is always important.
Containing your liabilities is relatively simple and generally makes good business sense. You might also consider including asset protection provisions in your estate plan for your heirs. If you have serious concerns, irrevocable and offshore trusts, as well as LLCs, may provide a safe haven.
Always consult with competent legal counsel when making these decisions, and consider the tax and other implications of reorganizing your assets.