Some clients arrive to meet with their Estate Planning attorney with an article in hand claiming that a particular firm, company, or other attorney creates “bulletproof” asset protection vehicles, often involving some form of “asset protection trust.” This puts the attorney in the awkward position of reviewing the article, then explaining why the method advertised may not have the intended result, and that the attorney will not undertake such planning because these schemes rarely work and come with significant drawbacks. In truth, few asset protection strategies offer an iron-clad solution to every problem. Asset protection planning, like estate planning, requires an understanding of the issues facing the client, knowledge of the various options available for the client based upon the situation and follow through. This first part of a two-part series will explore some of the most common asset protection techniques and their benefits and detriments. The second part will focus on foreign trusts and a situation that went terribly wrong.
Clients usually have some concerns regarding the level of asset protection that will result from the Estate Plan they create. As attorneys, we have numerous tools in our arsenal that allow us to suggest various techniques based upon the degree of protection the client desires and the client’s individual circumstances. Some asset protection planning takes little effort to implement. For example, one of the simplest ways to achieve a degree of asset protection requires obtaining an umbrella insurance policy. The umbrella policy covers accidents and injuries exceeding the coverage limits under your primary home, automobile, and boat insurance policies. It limits liability for your own injuries or damage to your own property and won’t cover things like intentional acts or injury, business losses, criminal acts, or business losses. Umbrella insurance requires little effort and provides significant protection.
Retitling assets offers another easy way to undertake asset protection planning. For example, about half of all states allow married individuals to take title to assets as tenants by the entirety. In the states that recognize this form of ownership, some allow it only for real property, while others allow it for any asset, real or personal. Tenants by the entirety ownership requires that a creditor be a creditor of both spouses to attach an asset titled in that manner. Holding an asset as tenants by the entirety protects the asset while the couple remains married and both spouses live. Upon the death of the first spouse, the asset passes by operation of law to the surviving spouse and the protection ends. Even in states that do not recognize tenants by the entirety as a form of ownership, individuals may avail themselves of other forms of ownership. For example, transferring income-producing property, such as a rental property, to a limited liability company (“LLC”) limits a creditor’s recourse to the assets in the LLC. Thus, a client could establish several entities and fund each with just one income-producing property thereby protecting each against creditors of another.
Giving the assets away removes the gifted assets from the reach of the donor’s creditors. The donor could gift outright to a spouse, child, or another beneficiary. Of course, the client’s circumstances at the time of the gift may cause problems. If the individual were divorcing or otherwise facing known creditor issues, a court may interpret the client’s transfer as a fraudulent conveyance. If the transfer constitutes a fraudulent conveyance, then the creditor may be able to unwind the transaction or obtain a money judgment against the transferee, depending upon state statutes. An outright gift offers no protection for the recipient.
If the donor wanted to confer a benefit but was against outright distribution to a beneficiary because of the lack of creditor protection, then contributing assets to a 529 Plan, a 401(k) or retirement plan could be a reasonable solution to the problem. These plans follow statutory requirements regarding allowable contribution amounts, beneficiaries, and distributions but yield another opportunity for an individual to undertake easy asset protection planning. Review your state’s statutes to understand the limits for a 529 Plan and federal statutes for 401(k) and retirement plans.
Certain types of trusts contain an asset protection component. For example, many irrevocable trusts used in advanced estate planning techniques such as a Qualified Personal Residence Trust, an Irrevocable Life Insurance Trust, and a sale to an Intentionally Defective Grantor Trust, all protect assets from creditors of the grantor if established prior to the existence of any creditor issues. In addition, if properly structured, these trusts provide asset protection for the beneficiaries of such trusts.
Finally, seventeen states, including Alaska, Delaware, Hawaii, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming allow for a domestic asset protection trust (“DAPT”). In simple terms, a DAPT is a domestic self-settled asset protection trust that names the grantor of the trust as a permissible beneficiary of such trust. Most states do not allow this. In the states that do, to obtain the protections of the state law, the individual trustee administering the trust needs to reside in the state of establishment. Alternately, the grantor could appoint a corporate fiduciary in that state. The trust usually contains a completely discretionary distribution provision which gives the trustee total control when making distributions from the trust. If the trust contained an ascertainable standard, such as health, education, maintenance, or support, then a creditor could stand in the shoes of a beneficiary and force distributions from the trust that met that standard. If a grantor creates a DAPT in any state other than the seventeen states listed above, a creditor could pierce a trust that names the same beneficiary and grantor. While the attorney should concern themselves with fraudulent conveyances, the states that allow DAPTs make showing a fraudulent transfer more difficult. As with many estate planning techniques, anyone desiring to establish a DAPT needs to follow state statutes carefully to achieve the desired protections.
Attorneys have multiple options at their disposal in structuring a plan to protect assets from creditors. When done properly, asset protection removes a client’s assets from their control, or otherwise protects the assets to the greatest extent possible, prior to problems arising. If that claim has occurred or the client knows that it will, the asset protection ship has sailed and any acts to protect those assets constitute fraud on creditors which may have undesirable consequences both for the client and the attorney assisting the client. The next article examines those consequences>
Tereina Stidd, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
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