Asset protection: Protect your assets with an asset protection trust

What is asset protection?

Asset protection is a strategy that you can use to protect your assets from the reach of lawsuits, judgments, and creditors. Both individuals and businesses might implement strategies when they conduct financial planning.

Some of the common strategies used include the following:

  • Domestic asset protection trusts (DAPT)
  • Spendthrift clauses
  • Limited liability companies
  • Family limited partnerships
  • Corporations
  • Limited liability corporations

Why would I need an asset protection trust?

There are several benefits of creating an asset protection trust. A protected trust can help limit personal liability in many situations. This could be in a divorce, from your creditors, because of medical bills, against personal injury judgments in auto accidents, and against property accident claims.

An asset protection trust can also protect you from professional liability for job-related claims, employment lawsuits, product lawsuits, malpractice, contract claims, and trademark infringement lawsuits. Timing when creating this type of trust is crucial. You are not allowed to transfer funds into trusts to protect them after a lawsuit is filed against you or when a lawsuit is about to be filed against you. If you do, the transfer could be considered to be fraudulent and open the funds that you have transferred up to the reach of the creditors.

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Lawsuits in the U.S.

We live in a litigious society and every year, many people and businesses face lawsuits. When they do not have adequate asset protection strategies in place, their property may be reached by creditors. Some people turn to bankruptcy protection to protect themselves from their creditors. According to the U.S. Bankruptcy Courts, 12.8 million petitions for consumer bankruptcy were filed between the years of 2005 and 2017.

Thousands of civil lawsuits are also filed every month. In May 2019, the government reported that there were 26,444 new civil lawsuits that were filed. According to data from the U.S. Department of Justice, 60% of the cases that were filed during a single year involved allegations of personal injury. These statistics illustrate the importance of learning how to protect assets in the case that someone files a lawsuit against you, or some other situation arises that could lead to creditors trying to reach your assets. A protected trust might help you to prevent creditors from being able to do so.

Asset protection planning

Asset protection planning involves taking the property that you own that is open to potential claims from creditors and moving it out of the reach of the claims. Proper planning includes taking proactive steps in order to protect your assets.

You will want to include asset protection as a component of your comprehensive financial plan. It should be determined by the type of property that you have and your own potential exposure to risk.

Domestic Asset Protection Trusts (DAPT)

A Domestic Asset Protection Trust is a type of irrevocable trust with a spendthrift clause that you can create for your own benefit. You will serve as both the settlor and the beneficiary of the trust. This means that you can receive occasional distributions at the discretion of the trustee.

A DAPT offers some asset protection from your creditors while allowing you to retain some control over the assets that are held by the trust. Many states allow you to create a DAPT even if you do not reside in the state. If you form one in a state that does not have state income taxes, you can also save money that you might otherwise have to pay.

To create a trust for asset protection, you must make sure that it meets the requirements. A protected trust must be irrevocable and have a spendthrift clause. The trustee must be someone who is a resident of the state in which the trust for asset protection is created or a trust company or bank that is licensed in the state. The distributions from the DAPT must be made at the discretion of the trustee.

The documents, administration, and some or all of the trust’s assets must be located in the state in which the protected trust has been established. The property that is held by these trusts can include cash, securities, limited liability companies, business assets, inventory, equipment, recreational assets, and real estate.

There are some limitations to domestic asset protection trusts. Trusts can be expensive to establish and maintain and there are only a few U.S. states allow people to establish these types of trusts.

Business Entities

In addition to forming a trust to protect your personal assets, there are certain types of business entities that can offer asset protection for business assets. It is important for you to understand the different types of business entities so that you can choose a legal entity structure that will provide you with the protection that you need.

Sole proprietorships do not provide you with any protection from personal liability. While it is easy to form and to operate a sole proprietorship, it might not be the best choice because of its inability to protect assets.

General partnerships between partners make each partner legally responsible for the other’s actions. A limited partnership allows you to limit your liability by the amount that you have invested in the business. However, there is a steadfast rule that you are unable to actively participate in the business if you have a limited partnership. If you assume an active role, you will be considered to be a general partner, which opens you up to being held personally liable.

Corporations are popular for asset protection. Except in the cases of fraud, your personal assets are protected from a lawsuit when your business is structured as a corporation. S-corporations and C-corporations are taxed differently and have different ownership limitations. However, both types of corporations offer protection for their owners.

Limited liability companies are very popular types of legal entity structures for businesses. These are fairly simple to set up, and they provide asset protection against business lawsuits for the business owners. There are fewer ownership restrictions than there are for S-corporations. With an LLC, you are given a choice of whether to file federal taxes as a partnership or corporation.

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The major benefit of an LLC is that it offers charging order protection. If a creditor is given access to your books from an award of shares of the business, the creditor cannot force a distribution of cash but can still be taxed as if the creditor received it. This feature may help to prevent a lawsuit.

Insurance

Family limited partnerships or FLPs are types of business structures in which the assets that are transferred to the partnership are exchanged for shares. The FLP owns the assets and retains control over the assets. The assets are protected from creditors under the Uniform Limited Partnership Act.

For protection to apply, you should never commingle your personal and business assets. If you do, creditors can pierce the corporate veil to try to hold you personally liable.

Insurance is important component that helps with asset protection. When you insure your home, for example, your homeowner’s policy will pay claims if someone is injured while they are visiting your property.

If you own a business, having commercial liability coverage provides your business with protection if someone is hurt on the property or suffers an injury because of an employee. If you have employees, you are mandated to carry workers’ compensation insurance. This coverage protects both you and your workers by paying the expenses that are incurred by an employee who is injured while working on the job.

Automobile coverage is another type of coverage. It protects you if your vehicle is involved in an accident. The total liability coverage of your automobile policy should be at least equal to the total value of your property.

Umbrella coverage is a supplemental type of coverage that covers expenses in the event that your auto, homeowner’s, or other coverage types are depleted. An umbrella policy will pay up to its policy limits.

Finally, long-term care insurance can help you to pay the costs of in-home care or nursing home care in the event that you suffer from a long-term illness. This type of coverage helps you to pay for your long-term care if and when you need them.

Retirement Accounts

Like protected trusts, retirement accounts can also be used to protect your long-term savings while providing you with tax benefits, depending on the type of account and the state in which you reside. Accounts that are covered by the Employee Retirement Income Security Act or ERISA are protected from creditors, bankruptcy proceedings, and civil lawsuits. To comply with federal rules, the retirement plan must be set up and maintained by your employer. ERISA plans include 401(k) plans.

Some exceptions to the protection of ERISA accounts include qualified domestic relations orders or QRDOs to divide them in divorces, child support, the IRS for federal income tax purposes, and the federal government for criminal fines and penalties. For these exceptions, funds in your ERISA accounts can be accessed.

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Accounts that do not fall under ERISA include traditional and Roth IRAs. For these accounts, both the contributions and earnings are protected up to $1 million in bankruptcy proceedings. The court has the authority to increase the amount. The funds are protected under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.

The asset protections offered by other employer-sponsored plans, including SIMPLE IRAs, 403(b), 457 plans, and SEP IRAS, are dependent on the state in which you live.

Alternative methods of asset protection

In addition to creating a trust, forming a legal entity structure, purchasing insurance, and contributing to retirement accounts, there are some other methods of asset protection. One example is transferring the title of property to your spouse’s name. However, this does not protect you in the event of a divorce, but it may help in the case of creditors.

Another alternative to creating a trust is using your homestead exemption. This is the amount of protection that you have on your home against creditors or lawsuits, and it varies from state to state.

Depending on your state, the homestead exemption might range from nothing to unlimited protection. If your state allows you to take a large homestead exemption, you might consider contributing more principal to your mortgage payments. If your state only provides a minimal exemption, making additional mortgage payments might not make sense if you are attempting to protect yourself from your creditors.

The protection of annuities and life insurance varies from state to state. Some states protect the cash value of a life insurance policy as well as the proceeds of an annuity contract. Other states only offer limited protection for the beneficiary. Finally, some states do not protect the cash value, proceeds, or the beneficiary of either one.

DISCLAIMER: To learn more about forming a trust and asset protection, you should seek the advice of a professional estate planning attorney. This article is educational in nature and is not meant to be legal advice.

A protected trust with a spendthrift clause can help you to protect yourself from being targeted by creditors. M1 Finance supports both revocable and irrevocable trusts that are authorized to invest in securities.

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