Is Asset Protection Planning necessary if I'm a High Net Worth Individual?
Building wealth takes years of disciplined decision-making, investing, and sacrifice. However, accumulating assets is only half the equation.
Without protection in place, the wealth you’ve created is vulnerable to things like lawsuits, divorces, and excessive taxation. That’s why most high-net-worth individuals and families consider asset protection planning an essential part of their financial planning.
What is Asset Protection Planning?
Asset protection planning is a part of financial planning where you implement certain strategies and structures to shield your wealth from potential financial threats.
Unlike tax evasion or other fraud, legitimate asset protection planning uses established legal strategies.
When you have significant wealth, you can become a target for litigation. Whether justified or not, lawsuits targeting the high net worth are more common than you’d think.
For example, if a real estate investor has one slip-and-fall incident on a rental property, it could trigger litigation seeking damages that exceed insurance coverage limits.
Beyond lawsuits, high net worth families also face challenges during divorces. For example, without proper planning a separation can result in the splitting or liquidation of assets (ex. the family business, etc.) that were supposed to stay in the family for generations.
Even if some event such as a lawsuit or divorce never happens, asset protection planning is still helpful to avoid estate and inheritance taxes taking large chunks of your wealth after you pass.
What Assets Can a Creditor Take?
When you don’t engage in asset protection planning, any of your assets can be vulnerable.
This includes family homes, vacation properties, business interests, and investment accounts.
And, the tax consequences can make things worse. For example, forced asset sales may trigger capital gains taxes. Assets that could have been transferred tax-efficiently through proper estate planning instead face unnecessary tax burdens.
What are some Asset Protection Strategies and Structures?
Limited Liability Companies and Family Limited Partnerships
Transferring ownership of real estate, investment accounts, or business interests into LLCs or FLPs creates legal separation between yourself and your assets. These entities can also provide charging order protection, which limits creditors to only accessing asset distributions (i.e. profits, dividends) rather than being able to access or sell the entire asset. They also offer valuation discounts for gift and estate tax purposes.
Irrevocable Trusts
When assets are transferred into irrevocable trusts, they are removed from your personal estate which generally makes them unavailable to creditors. Two examples are:
Domestic asset protection trusts (only available in Alaska, Delaware, Hawaii, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia and Wyoming), which allow you to be a beneficiary while still maintaining protection.
Spousal lifetime access trusts can provide your spouse with access to trust assets while keeping them outside your estate.
Insurance
Insurance is a standard first line of defense. Umbrella liability policies provide coverage beyond standard limits, and professional liability insurance protects against malpractice claims. However, insurance should not be your only protection since coverage limits exist, exclusions apply, and insurance companies sometimes deny claims.
Automatic Homestead Exemptions
Many states offer homestead exemptions that protect your primary residence from creditors. With these, you are entitled to a protection of some of the equity in your primary home.
Read more about CA Homestead Laws here: https://calawyers.org/real-property-law/what-is-a-homestead-exemption/
Read more about ID Homestead Laws here: https://tax.idaho.gov/taxes/property/homeowners/exemption/
How Does Asset Protection Planning Work with Tax Planning?
The two are interconnected. Decisions made for asset protection have significant tax implications, and certain tax structures can help or hurt asset protection goals.
Transfers to irrevocable trusts are usually considered completed gifts for tax purposes, which can trigger gift tax consequences if they exceed annual exclusion amounts. These transfers are usually done to remove assets from your taxable estate, which can potentially save substantial estate taxes if done correctly.
Valuation discounts available through FLPs and LLCs also provide opportunities to transfer wealth to the next generation at reduced gift and estate tax costs.
State income taxes also have an influence. Some states tax trusts differently than individuals, so a trust created in one state to take advantage of its asset protection laws might create unfavorable tax consequences if not structured properly.
The timing of asset protection planning also has tax implications. Transfers made within three years of death may be pulled back into your estate for estate tax purposes under certain circumstances.
Asset protection planning is an essential part of wealth management for high net worth individuals and families.
Its complexity with compliance of state and federal laws, tax regulations, trust and entity structures, and insurance strategies makes professional guidance important.
These structures must be created correctly, properly funded, and maintained over time to stay effective.
As always, we recommend working with a professional who understands both tax strategies and wealth management.
Author: Rob Cucchiaro, CFP, CRPC, AAMS
Questions answered in this blog:
What is asset protection planning?
What can asset protection planning protect against?
What assets can a creditor take?
Why is asset protection planning important?
What are some asset protection planning strategies?
How can establishing an LLC be an asset protection planning strategy?
How can establishing an FLP be an asset protection planning strategy?
Which type of irrevocable trust should I establish if engaging in asset protection planning?
How can establishing a domestic asset protection trust be an asset protection planning strategy?
How can establishing a spousal lifetime access trust be an asset protection planning strategy?
This material is purely intended to be general and educational in nature, and should not be construed as specifically-tailored investment, financial planning, tax, legal, or other professional advice. Information and data contained herein is as-of the date of publication, and may be subject to change in the future without notice. Any investment performance referenced is purely past performance, which is no guarantee of any future performance. Nothing contained herein should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation of any security or other financial product or investment strategy. All investment, tax, and financial planning strategies involve risk that you should be prepared to bear. You are highly encouraged to consult with professionals of your choosing before taking any action based on this material.