Asset protection doesn’t get nearly enough attention from financial advisors and as a result, their clients are opening themselves up to extra risk. Often advisors will talk about investing, taxes, retirement planning, and then if there’s time left at the end of the meeting, the advisor might throw in a few bits about insurance and risk management… blah, blah, blah.
But protecting what you’ve already earned or saved is essential. And with a few well chosen strategies, anyone can put together a solid protection plan.
Rule #1 – Use Common Sense
Question: what’s the number 1 cause of nonfatal injuries in the U.S.? Answer: unintentional falls. What can you do to prevent an unintentional fall? Use common sense. Install railings, remove obstructions, and stay off your ladder. Also, get enough exercise to maintain your muscular strength and balance.
As with falls, the same concept applies to asset protection. If you’re worried about being sued, then take some commonsense precautions. Don’t drive like an crazy person (and take the keys away from your teenagers if you can). Trash the giant trampoline in your yard. Put a fence around your pool. Keep your dog on a leash. Make sure your outdoor walkways are clear. Be nice to people. You don’t have to live like a hermit, but taking reasonable steps to reduce your exposure makes sense.
If you’re a professional such as a doctor, attorney, engineer, or CPA, then you have to get comfortable with a certain level of risk. You can’t stop seeing clients or patients, because you have to earn a living, so you will always maintain a certain baseline level of exposure. But there are things you can do to help. Stay up to date on your training and professional development, follow industry best practices and checklists, and check whether your employer will indemnify you against legal action.
Watch your reputation
You can also manage your “wealth reputation”, with the idea being that if nobody knows you’re wealthy, then it’s less likely they’ll sue you. To achieve this, you might choose to live in a small house, drive an old beat up car, and dress in thrift store clothing. I’m skeptical that driving a 1995 Honda Civic will protect you from a lawyer looking for assets, but I suppose it wouldn’t hurt to try (unless the A/C is broken in that Civic and it’s summertime in Virginia).
Rule #2 – Get Insured
I understand that buying insurance is about as much fun as going to the DMV. Given the choice on a Friday night, I’m choosing to watch Netflix and skipping that super fun insurance application. But going without insurance is rolling the dice on financial ruin so I urge you not to skip it.
Personal Liability Coverage
Start by maxing out your liability coverage on your homeowners (or renters) and auto policies. You can reduce the premium hit by increasing the deductible at the same time. For additional liability coverage, get an umbrella policy. Umbrella coverage layers on top of your home/auto policies to provide extra protection above and beyond the standard limits. A good rule of thumb is to aim for liability coverage equal to 100% of the portion of your net worth exposed to creditors (in rule # 3, we’ll discuss how to protect certain assets from creditors). So if you have a $5 million net worth, but $2 million is in your 401k, then creditors can likely only seize the other $3 million. So you should aim for umbrella coverage of around +/- $3 million. The vast majority of people will get adequate protection from $1 – 2 million of umbrella coverage.
Professional and Business Coverage
If you are a professional (i.e. doctor, attorney, CPA, engineer) with exposure to malpractice lawsuits, then you’ll also need professional liability insurance. If you work as part of a group practice, this insurance is often provided at the group level, but not always so you’ll want to confirm.
Any small business owner needs to explore a general liability policy for their business. This type of policy generally provides the same benefits as personal liability coverage, but for the business itself. It can cover you in case someone gets injured at one of your business locations or if your delivery truck gets in an accident.
Rule #3 – Use What’s Readily Available
In addition to insurance, there are many readily available pathways to protecting assets from creditors and reducing the exposure of your assets to lawsuit judgements. And these don’t really cost anything to set up.
Homestead Exemption
Many states protect part or all of your residence from creditors. Some states are better than others (i.e. Florida and Texas), but most states offer at least a minimal amount of protection.
Asset Titling
For married couples, one great tool is Tenancy by the Entirety asset titling. Commonly referred to as “T by E”, this titling choice basically makes each spouse a 100% owner of the asset. So any creditor of one spouse cannot seize the asset, because both spouses own it. Similar account titles such as Tenants in Common and Joint Tenants with Right of Survivorship do not offer the same level of creditor protection. If you have a trust designed to protect assets, make sure you follow your attorney’s instructions for titling the assets in the name of the trust, otherwise the assets can remain exposed.
Retirement Accounts
Retirement accounts offer great asset protection. ERISA qualified retirement plans (i.e. 401k, 403b, etc) tend to offer the best protection, but depending on which state you live in, your IRAs could also be exempt from creditor actions. Sometimes the assets in retirement accounts are only protected up to a cap or level that the judge deems reasonable to support yourself, which may not line up with what you think is reasonable to support yourself. But that just brings us back to Rules #1 and #2.
An extra note on inherited IRAs: the U.S. Supreme Court determined that inherited IRAs are not eligible for creditor protection so you’ll need to make alternative arrangements (such as a trust) if you want to protect those accounts from any beneficiary creditors.
Rule #4 – Other Legal Entities
There are a variety of legal entities that you can use to help with asset protection. Some of these options can cost a decent amount of money to set up and manage effectively, so they really only make sense for people with a higher net worth. I won’t go into all of them here, but they include a whole kaleidoscope of trusts, limited liability companies (LLCs), corporations, and certain partnerships.
Rule #5 – Stay Up To Date
Once you have a plan in place, maintain it. The rules can change depending on what Congress or your state legislature does. Speak with an estate planning attorney every few years to make sure everything is still in working order. As your net worth grows (or the rules change), estate tax liability may become a planning focus, so keep that in mind as well.
