Understanding Asset Protection
Safeguarding your wealth is as important as building it. Even if you make all the right decisions in accumulating and growing wealth, neglecting to protect it can ruin your financial plan.
What Is Asset Protection?
Asset protection is a set of legal strategies used to help shield individual or business assets from losses due to legal judgments, seizure, taxes, and claims by creditors or beneficiaries. For example, there are strategies that can limit a business’ liability in case of a lawsuit or protect personal assets in a divorce.
Asset Protection Is Essential
Asset protection is most useful for people with significant assets, because these very assets can make them a bigger target for lawsuits and claims. Occupation can play a role, too. Business owners have additional risk associated with their business’ operation and dealings with employees and customers. Highly paid professionals with job-related risk, such as surgeons, are also at higher risk.
But no matter who you are or what you do for a living, if you have assets, you need a proactive and well-thought-out asset protection plan to help counter any legal challenges you might confront in the future. Once a lawsuit or claim is filed, it may be too late to take effective measures.
Assessing Your Financial Vulnerabilities
The first step in protecting your assets is understanding what you have and what risks you could be exposed to.
Evaluating Your Assets and Goals
Of course, you need to know exactly what you own. This means not only cash, but also investments and real property. You should take inventory on a regular basis anyway, so this is likely already part of your financial plan.
To properly protect yourself, you also need to evaluate the goals you have for your money and assets. If certain assets are earmarked to pay for your retirement or for your granddaughter’s college education, that can make a difference in how you structure protective measures.
Identifying Potential Financial Risks
It also helps to think about the types of risks you could face and which are most likely in your circumstances. Consider the potential for lawsuits, divorce, creditors, bankruptcy, etc. Sometimes this is hard for people to do. No one wants these negative things to happen, and we tend to ignore things we don’t want to happen. Bringing your financial advisor in on the discussion early may help you take a clear-headed approach to these emotional issues.
Legal Structures for Asset Protection
Several legal structures are available that can help you safeguard your assets, depending on the type of assets, type of potential risks, and your goals for preservation.
Using Trusts for Protection
Irrevocable trusts can be excellent vehicles for asset protection. An irrevocable trust is a legal arrangement that takes specified assets out of your hands and transfers ownership to the trust, for the benefit of stated beneficiaries.
“Irrevocable” means you cannot change or dissolve the trust once it’s created. Because you legally neither own nor control the trust’s assets, they are out of reach of any legal action directed at you. Asset protection trusts can be set up for an individual or business and have the following benefits:
- A court or creditor cannot compel you to give up these assets.
- The assets can be invested to grow and generate income, potentially for generations to come.
- The assets are accessible to beneficiaries, including you and your children or grandchildren, now or in the future.
Family Limited Partnerships (FLPs)
Family Limited Partnerships allow family members to own shares in a family business, with potential protection from creditors, estate and gift taxes. FLPs are often established to preserve a family’s generational wealth, because they allow for tax-free transfers of assets, real estate, and other wealth.
All partners must be related to each other — spouses, parents, grandparents, children, or grandchildren. There are two types of partners. General partners take part in the day-to-day aspects of the business while limited partners own a piece of the business but do not take part in day-to-day management or executive tasks.
These types of partnerships protect assets by keeping them within the family. Non-family investors are not allowed to become involved in ownership of the business, and a limited partner who leaves the family, such as in a divorce, must return the shares back to the business.
Note however that general partners of an FLP are personally liable for business debt or bankruptcy and can be required to hand over personal assets to cover the business’ financial obligations.
Because the structure of FLPs and the tax laws that govern them are complex, families should consult qualified financial and tax advisors before establishing an FLP.
Incorporating Your Business
Debts to landlords and vendors, damage and accident claims, product or professional liability, and breaches of contract are just some of the risks business owners may have to deal with. Unlike a family limited partnership, incorporating your business can protect your personal assets from these claims by establishing your business as a separate legal entity.
If your business is incorporated as a C corporation, S corporation or Limited Liability Company (LLC), you have no personal liability for corporate liabilities and creditors generally can only pursue corporate assets to satisfy a claim. There are different legal and tax requirements for the different types of corporate structures, but all could provide personal asset protection.
Insurance as a Protective Measure
Insurance is the simplest protection measure you can put in place to safeguard assets from creditors and claimants, which can make it an excellent first step in building your asset protection plan.
The Importance of Liability Insurance
Liability insurance essentially transfers financial risk from you to your insurance company. If a risk actually materializes, whether it’s damage, theft, contract breaches, etc. the insurance company stands liable for the risk and your personal assets are protected.
What Is Umbrella Insurance?
Umbrella coverage is excess personal liability coverage – it protects you from major claims and lawsuits that exceed the limits of your regular liability policies. You should consider purchasing enough personal umbrella coverage to cover most or all of your assets that could be impacted, including real estate, expensive real assets, and investment accounts. There are two main benefits of this insurance:
- It closes gaps (attorney fees, etc. that are not covered) in your property and casualty policies (home, boat, and car insurance) and can provide additional liability coverage above the limits of these policies.
- It may also cover claims excluded by other liability policies.
In addition to umbrella coverage, you may want to consider specialized insurance related to your specific circumstances, such as kidnap and ransom insurance, identity fraud protection, or employment practices liability insurance.
Evaluating Coverage Limits
Don’t skimp on coverage to save money in the short-term. Always assess the value of your assets and make sure you have enough coverage to protect them.
Also, regularly review and update your policies as your assets and circumstances change. Don’t forget to increase your coverage limits as you need to.
Proactive Asset Protection
Timing and Preemptive Measures
Individuals with substantial assets are more likely to be targeted by claims, so don’t put off building an effective asset protection plan. If you don’t have one in place when risks materialize, it may be too late to fully protect your assets, family, and financial future. And remember to review your plan regularly, to help ensure you’re still protected as your wealth grows over time.
Engage Legal and Financial Advisors
Asset protection can be a challenging process, due to the intersection of legal and financial complexities. Given its importance, you should know how to use the available legal structures appropriately and effectively. Consult an attorney and a financial advisor to explore the use of structures like trusts, limited liability corporations, insurance policies, and family limited partnerships to help protect your assets from potential lawsuits and creditors.
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Alex Jensen is not registered with Cetera Advisor Networks LLC. Any information provided by this individual is provided entirely on behalf of CWM, LLC and is in no way related to Cetera Advisor Networks or its registered representatives.
