Asset protection strategies can be used for a variety of purposes. Perhaps you have clients who work in high-risk professions. Others could be seeking divorce protection. Or perhaps they simply want to protect themselves against an unforeseen accident or unfortunate circumstance. But how can you help your clients decide which strategy best meets their needs?
Of course, no strategy can protect 100 percent of an individual’s net worth, but the right solution can protect enough to keep a client going, help him or her start over, or ensure a sound retirement. Keeping in mind that maintaining reasonable goals and tempering a client’s need for control are common challenges, here I’ll discuss three asset protection strategies your clients can use to safeguard their assets.
1) Domestic Asset Protection Trusts
A domestic asset protection trust (DAPT) is an irrevocable trust that a client creates for his or her own benefit. There are generally two primary goals:
- Protect assets from creditors
- Retain access to the trust assets (at the trustee’s discretion)
As of September 2016, 16 states have passed legislation authorizing the use of asset protection trusts: Alaska, Colorado, Delaware, Hawaii, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, and Wyoming. Under DAPT legislation, the grantor can keep assets in the U.S., remain a discretionary trust beneficiary, and receive spendthrift protection from certain creditors. As the law has developed, state statutes have issued varied requirements; however, typical provisions address the following issues:
- The trust must be irrevocable
- Whether the grantor may be a discretionary, income, or principal beneficiary of the income and principal
- Whether there is a requirement for the trustee to be located in the DAPT state
- Whether some administration of the trust must take place in that state
The trustee’s role. The trustee’s role is to administer the trust by distributing assets in accordance with the trust distribution provisions. Also, the trust document may authorize protective strategies, such as the appointment of an independent trustee or trust protector, the decanting of trust assets, or other administrative responsibilities.
Protection limitations. DAPTs won’t protect clients against every creditor. State laws vary, and certain creditors may be allowed access to trust assets, including:
- Divorcing spouses
- A child entitled to child support
- A prior creditor whose claim arose before or on the date assets were transferred to the trust and who files suit within the state’s statutory time frame
- A future creditor whose claim arises after assets are transferred to the trust and files suit within the state’s statutory time frame
- Claims arising as a result of death, personal injury, or property damage caused by the grantor before the transfer of assets to the trust
Fraudulent transfer. Every client who transfers assets to a DAPT should be careful to avoid fraudulent transfer. If there is evidence that a grantor intended to defraud a creditor, the creditor may reach the trust assets. Professional counsel is necessary, as state law and case law vary regarding fraudulent transfer rules.
Tax considerations. DAPTs may be drafted for two key reasons.
- If asset protection is the key objective, irrevocable transfers to the DAPT are an incomplete gift, and the assets are included in the grantor’s estate for estate tax purposes.
- If estate planning is also a key objective, transfers to the trust are a completed gift, and the assets are intended to be excluded from the grantor’s estate.
Whatever the purpose, clients should be aware of income and transfer tax concerns that may be involved in establishing a DAPT.
Third-Party Spendthrift Trusts
Another option is the third-party spendthrift trust, established by a client for the benefit of another individual. Third-party trusts often include spendthrift provisions designed to protect the trust assets from the trust beneficiary’s creditors or from the beneficiary’s spending habits. Another common planning goal is asset protection in the event of a child’s divorce.
Here, discretion is an important benefit. The trust accomplishes asset protection simply by directing the trustee on how to control and distribute the trust money. Also, the spendthrift trust provision prevents a beneficiary from assigning or pledging his or her interest in future trust assets. Keep in mind that public policy exceptions do exist (e.g., claims for child support), and trust provisions that specify ages for distribution, or give the beneficiary the right to demand assets or terminate his or her interest in the trust, are typically held to be a property right available to the beneficiary’s creditors.
Trust assets are managed by the trustee according to directions specified in the trust and statutory guidance. Although the beneficiary may act as a trustee, his or her control over the trust assets should be limited. With this type of trust, appointing an independent or corporate trustee may afford greater asset protection.
Limited Liability Companies
Entities such as limited liability companies (LLCs) have long been used as a strategy to transfer assets in a tax-efficient manner, minimize a client’s estate for estate tax purposes, and maintain a controlled ownership transfer. But clients may also use an LLC for asset protection.
With an LLC, the underlying assets are typically protected because the creditor’s remedy is a charging order against the membership interest.
- A charging order is a lien giving the creditor the right to receive distributions from the LLC that would otherwise be distributed to the debtor.
- A charging order will not give the creditor access to the debtor’s ownership of the underlying LLC assets.
- As the debtor’s controlling interest may limit LLC distributions, the creditor may receive little or no payment, making charging orders an unattractive remedy.
When considering an LLC, state law may be a deciding factor. Specifically, many states allow creditors to use more aggressive tactics to force a disposition of the underlying assets or seek a judicial foreclosure. Further, even if the entity’s underlying assets are protected, an LLC doesn’t protect the member’s lifestyle, and a debtor may never enjoy his or her property interest.
What’s the Cost?
With any asset protection strategy, clients should work closely with an attorney to structure the plan and discuss the costs (e.g., initial planning and ongoing maintenance). The level of assets to be protected should be considered in order to select the most cost-effective type of planning.
There are also administrative aspects to consider. It’s not uncommon for a well-intentioned client to transfer assets, make statements, or take other actions that can undo a plan already in place. This is where you can provide real value for your clients: keeping an open dialogue with the client and his or her attorney can help safeguard the plan.
What’s Right for Your Client?
In deciding on the right asset protection strategy, consider the following:
- What is the client’s current financial status? Does he or she expect this status to change?
- Is the client aware of any potential litigation or creditors that may make a claim?
- Does the client have the administrative acumen and willingness to carry the plan forward?
- Does the irrevocable nature of many asset protection strategies give the client pause?
- Is the client prepared to relinquish control? To what extent?
- Will the transfer of assets leave the client in a position to be rendered insolvent or unable to meet future financial obligations?
Be the Quarterback
Of everything discussed here, the most critical point is helping your client avoid unreasonable expectations. No asset protection planning technique is foolproof. The key is helping your clients balance competing goals and understand the benefits and limitations of any plan. Once a decision is made, be the quarterback—engaging the client’s attorney and CPA to keep the asset protection plan on track.
Do you consistently work with your clients’ attorneys on asset protection plans? Which strategy do you find most effective for your clients? Please share your thoughts with us below.