Should I consider an asset protection strategy for my family?
Asset protection strategies aren't necessary for every affluent family. Many high-net-worth families may choose not to use them, or may place only a fraction of their wealth into trusts and other vehicles designed to protect assets. Why? Many asset protection strategies can significantly reduce the control and flexibility owners can exert over their assets.
That trade-off makes sense for some people. For instance, if you're a doctor, lawyer, landlord, or accountant—professions that carry a higher risk of litigation—you may have a greater need for asset protection strategies than other people do. If so, you may find that the benefits of protecting your wealth outweigh the drawbacks of giving up some control over it.
Understanding current protection rules
Before pursuing elaborate solutions, make sure you understand the current rules that can help protect your assets.
Primary residence
Many states have laws that protect assets such as a family's primary residence from creditors and lawsuits. The level of protection varies by state; some states offer generous protection while others offer relatively little. Be sure you know how your primary residence is covered. In addition, some states require that a homestead exemption be filed with the county recorder in order to obtain homestead protection for a primary residence.
Retirement plan accounts
Assets held in qualified retirement plan accounts, such as a 401(k) account and individual retirement accounts (IRAs), often carry protection from creditors and litigation.
- Employer-sponsored plans: Under the Employee Retirement Income Security Act (ERISA), assets held in certain employer-sponsored retirement plans are generally protected from judgments in bankruptcy and from certain lawsuits.
- IRAs: Federal law generally protects up to $1 million in total IRA assets from creditors in bankruptcy proceedings (but note that inherited IRAs do not receive the same bankruptcy protections). The limit is adjusted every 3 years; as of April 1, 2022, the limit was increased to $1,512,350. All rollovers from employer plans are protected, and they don’t count toward the capped limit. Outside of bankruptcy, state laws determine the degree of protection on IRA assets. These laws can vary widely from state to state. Your attorney can help you understand any applicable laws in your state.
Other protection solutions
Insurance: A simple, but limited solution
The simplest way to protect assets against creditors or legal judgments is through insurance coverage. Umbrella policies are often very cost-effective, offering a great deal of coverage at a relatively low cost. The coverage varies from insurer to insurer, as does the cost and availability. Review a potential policy carefully with your insurance agent or other expert to make certain your coverages are consistent with your expectations.
Simple umbrella policies may not offer all the protection some families may require, however. Doctors, accountants, and even residential and commercial landlords may want considerably more protection for their assets in case legal issues arise.
Asset protection trusts
Individuals can place assets in these irrevocable trusts and name beneficiaries that eventually can inherit those assets. The individual effectively relinquishes control of the assets in the trust, but may continue to benefit from them, with distributions directed by the trustee, if properly established. The upside of these trusts is that they offer considerable protection from creditors. The protection isn't absolute, however: Many states don't allow asset protection trusts, so individuals who live in those states need to establish the trusts in states that do allow them. Setting up a trust outside the state of residence adds complexities to the process, and may even weaken the protection that the trust can provide. For instance, a court in a non-asset protection state may not completely uphold another state's rules. Again, speak with your attorney to discuss this strategy in light of your personal situation before moving forward.
Partnership solutions
For certain assets, such as real estate, a limited liability corporation (LLC) or limited partnership (LP) designation may provide an effective way to add a layer of protection against creditors. Consider the example of an owner of a residential apartment building. Transferring the property to an LLC or an LP may segregate the property from the owner's other assets, so that the owner's savings or primary residence might avoid being placed at risk in a tenant lawsuit.
Most asset protection strategies present both opportunities and drawbacks, so individuals should carefully weigh their options with their attorneys and tax advisors before placing assets in irrevocable trusts, LLCs, LPs, or any other structure.