By: Ed Bowen, CLU®, ChFC®, CIMA®

“Asset protection” has traditionally referred to the strategies designed to offer clients protection from creditor claims. However, in recent years, asset protection has expanded to include a broad array of estate planning techniques designed to facilitate the transfer of assets by reducing or eliminating income, gift, estate and generation-skipping taxes.  Some of these techniques are fairly simple while others can be quite complex.

In our litigious society, wealthy individuals and business professionals are exposed to excessive liability risks and are becoming increasingly interested in adopting asset protection strategies. Some of your clients may consider our legal system to be unpredictable and may be wary of the government’s tendency to pass new legislation with potential liability consequences. Such clients have a serious need for advanced estate planning strategies, including asset protection planning. Fortunately, there is a wide variety of domestic and offshore strategies that can help address this need.

DOMESTIC STRATEGIES

Multiple-Entity Planning

Sophisticated estate plans utilize “multiple-entity planning” which dictates that wealth should be placed in isolated, tax-sheltered legal compartments. Such entities would include certain types of business structure, trusts, foundations and qualified retirement plans as well as insurance and annuity products. While instrumental in tax and wealth transfer planning, these entities also offer the additional benefit of asset protection. However, state law may vary in what a specific state offers in the way of creditor protection.

Life Insurance and Annuities

In many states, life insurance and annuity contracts are exempt from the claims of creditors. However, the degree of protection varies depending upon pre-death versus post-death statutes, the named beneficiary and the status of premiums. Since these regulations are state-specific, please refer to your state’s statutes for guidance.

Retirement Plans

Federal law offers protection for the assets of qualified retirement plans from the employer’s or employee’s creditors. States may have additional exemptions that apply to assets after they have been distributed from a qualified plan, but these protections will vary by state. Please note, however, that the Employee Retirement Income Security Act (ERISA) provides no protection for employer-sponsored non-qualified deferred compensation plans or individual retirement accounts.

Business Structure   

Individuals and business professionals are often engaged in activities that have inherent liability risk. By placing the activities that generate these risks into a limited liability entity, such as a corporation, limited liability company or limited partnership, clients can isolate their remaining wealth from the liabilities often associated with such activities. The limited liability entity selected will depend on the degree of exposure, the level of complexity desired and the client’s overall estate planning goals.

Regardless of the type of entity utilized, protecting the integrity of the entity is paramount. Preserving the financial life of these entities and segregating them from that of their owners is critical to their success as asset protection vehicles. Pursuant to that goal, owners should avoid such common mistakes as paying personal expenses from business accounts or having a business entity own a personal residence and allowing a member or partner to use that property rent-free.

Gifts and Trusts

Significant asset protection can be achieved through the use of traditional estate planning techniques, such as gifting and trust arrangements. A consistent gifting plan would typically include present interest gifts to individual beneficiaries or philanthropic gifts to charitable organizations. Leaving assets to a beneficiary in trust has been the most common method of shielding assets from the claims of the beneficiary’s creditors or saving the beneficiary from himself. There are numerous domestic trusts available for asset protection purposes, and the alternatives should be properly reviewed. Clients should always consult with qualified legal counsel for guidance in this area.

OFFSHORE TRUSTS

There are two primary benefits to offshore trusts. First, it is possible for a settler to create an asset protection trust and remain a beneficiary of the trust. Second, because jurisdiction of an offshore trust is held outside of the United States, it is less likely to be targeted as a source of assets for satisfying a future judgment or claim. The difficulty in accessing the trust might influence a potential future claimant’s decision to pursue legal action, or at the very least, might cause the claimant to settle in ways that would be more favorable to the defendant.

Selection of a jurisdiction can present a challenge because of the need to become knowledgeable with the laws and the economic and political climates of multiple jurisdictions. The Principality of Liechtenstein, Cook Islands, Isle of Man and the Cayman Islands are the most well known, and many of these locations market themselves as optimal asset protection venues. However, a qualified advisor should carefully review the details.

Before implementing sophisticated asset protection strategies, your clients should keep in mind that there are laws against fraudulent transfers that are designed to delay or defraud creditors. The general principle is that if a court determines that an asset transfer is fraudulent, a creditor can set aside the transfer. The key question in this determination is whether the transfer was made sufficiently in advance of a creditor obligation so as not to be deemed fraudulent. Your clients should work with their advisors to conduct a solvency analysis and develop a creditor protection plan to fulfill obligations to all present and potential subsequent creditors that may exist. Such an approach will make it extremely difficult for any creditor to sustain a fraudulent transfer argument.

In the context of multiple-entity planning, no single solution represents a silver bullet. But by combining traditional estate planning techniques with non-traditional offshore trusts arrangements, your clients can develop an asset protection plan that should be able to withstand the most aggressive challenges from both creditors and predators.

Note: 1st Global does not provide tax or legal advice.  Prior to implementing any onshore or offshore trust, clients should seek guidance from qualified legal counsel regarding compliance with U.S. trust and tax regulations.

As manager of 1st Global’s Advanced Case Design group, Ed Bowen coordinates the overall planning and implementation of complex financial strategies involving high net worth individuals and closely held business owners.

This article was originally published in the November issues of CPA Magazine and Current Accounts.