Asset protection planning is a growing area of practice for many
members of the estate planning team. But, it is not something that one
member of the team can do alone. It may not take a village, but it does
take a team.
In addition to specific legal strategies that may
be of critical importance in planning for high-risk professionals and
others at risk, there are financial strategies that will substantially
increase the likelihood that an asset protection plan will achieve its
intended objective. Likewise, without cooperation among the advisor
team, there is great likelihood that the plan will fail to be
implemented or fail in practice.
In this issue of The Wealth Counselor,
we will examine a variety of asset protection strategies - from rather
simple to quite complex, how they work, the levels of protection they
can provide, how these strategies can work together, and the advisor
team approach to asset protection planning.
The Advisor Team Approach: The Three-Meeting Strategy
Asset
protection planning starts with client and advisor awareness. Moving
from awareness to implementation is best accomplished through a logical
sequence we call the “Three Meeting Strategy.” Here’s how it goes:
A
member of the advisor team will have that initial conversation, and the
client, being or becoming aware of their personal need for some asset
protection, will express interest. The very next step should be for the
advisor to bring in the rest of the team so that the case can be
evaluated and the options for the client identified.
1. Initial Meeting - Awareness: In
this meeting, the client (or prospective client) and a member of the
advisor team first discuss asset protection. That first discussion may
be with any team member – financial advisor, CPA, life insurance agent,
retirement plan administrator, attorney or some other. If this is the
first meeting between the advisor and a prospective client, the central
purpose of the meeting will be to gather basic financial information,
discuss the client’s objectives and establish a relationship with the
client. Asset exposure is just one facet of that discussion.
Planning Tip: Because
asset protection planning is most attractive to those who have a higher
than average risk of being sued, it is critically important to
determine early how much information the client is willing to share and should share
with various members of the advisor team. For example, it may be vital
to preserve attorney/client privilege and therefore not share specific
risk information with non-attorney advisors who could be subpoenaed.
2. Advisors’ Meeting: After
the initial meeting, the advisor team meets together without the client
present to brainstorm. They review the client’s objectives, discuss
various legal and financial solutions, and determine a consensus
solution to meet the client’s need.
Planning Tip:
It is critically important to “vet” all potential ideas and concerns
here, not in front of the client. Failure to do so can, and often does,
doom the planning – which hurts both the team members and the client. A
unified solution implies wisdom. If there is dissention in the team, the
client will sense it and often end up doing nothing.
3. Client Solution Meeting:
With a plan in agreement among the advisor team, the final meeting is
to present that plan (including all of its legal and financial
components and costs) to the client and get the client’s approval to
proceed. The probability of success at this meeting is enhanced by
having more than one team member present. A trusted advisor nodding in
approval while another team member makes the presentation is an
extremely powerful influence on the client.
Planning Tip:
Communicating with the client in the most effective way enhances
success probability. Some people are auditory learners, some tactile,
and some visual. If the learning style of the client is unknown, deliver
the message in multiple styles. Also, determining the client’s social
style profile (analytical, driver, expressive or amiable) will enable
the team to communicate with the client much more easily. (Search online
for “social style profiling” for more information.) Depending on how
long the lead team member has known the client, he or she may be able to
convey that information to the other team members to help them prepare
for the Solution meeting.
Talking Points for the Initial Meeting
In
the initial meeting, it is important to lay the groundwork and set some
reasonable expectations for how asset protection planning works. It is
useful to explain what asset protection is and isn’t, how the laws work,
and what they can expect.
What Asset Protection Is and Isn’t
Asset
Protection is not about hiding or concealing assets. It is about using
the existing laws appropriately to obtain the best possible level of
protection for the client’s assets in case an attack comes along.
Objectives
During the initial meeting, discuss client objectives.
* Most people would like to have a high degree of certainty
of the outcome. You may have to temper their expectations by explaining
how the law works and that there may be circumstances that nobody can
effectively control. Asset protection is time consuming, but worthwhile -
the end result should be considerably better than if the client had
done no planning at all.
* Many clients want to maintain control
rather than shift assets to some unknown third party in a foreign land.
The preferred approach is to maintain control or at least oversight
over the assets.
* An effective plan will discourage lawsuits from the outset.
We cannot make the client’s assets appear not to exist, but we can
create a structure that will make it much less attractive for a
potential plaintiff to go after our client than to go after someone who
has done no planning.
* Clients should avoid liability traps
such as owning assets in general partnerships or in joint ownership
where they are exposed to problems and risks another owner may have.
Types of Risks
Professional Liability:
Those who most often need asset protection planning have professional
liability risks – such as physicians, surgeons, dentists and other
health care professionals, lawyers, architects, accountants, and
sometimes those involved with business enterprises that pertain to
health care, such as skilled nursing facilities and assisted living
facilities. Those in construction (builders, developers) are also
concerned. And, in a down economy, some people are concerned about
having signed personal guarantees for real estate development or other
purposes.
As a general rule, one cannot limit one’s own
professional liability through a legal device. Also, most state statutes
do not permit nonprofessionals to own a portion of a professional
practice. For those concerned about professional liability claims, the
best first step is to have adequate malpractice insurance.
Professional Liability of Others: A
physician or surgeon needs protection against malpractice claims
against others in the practice. They will want to know what can be done
to protect themselves from that exposure. Putting that protection in
place is a good second step beyond having adequate malpractice coverage.
Non-Practice Personal Liabilities:
These could be business deals (possibly real estate) that have gone bad
or tort claims (car accidents, etc.). Even within the practice there
could be non-professional liability claims, such as employment
practices, employment discrimination, sexual harassment claims, and even
such things as slip-and-fall claims.
Other Liabilities:
These include income and estate taxes; a practice member’s spouse or
ex-spouse claiming an ownership interest in the practice or another
entity; children’s spouses and ex-spouses and their behavior which can
lead to loss of family assets, etc.
All of these are meaningful risks that should be addressed in that initial meeting.
Planning Tip: Almost everyone knows about someone who had some kind of problem and then lost everything.
When to Plan
The
best time to plan is before the claim arises. There are different rules
that apply for known creditors and unknown future creditors. But even
with an existing claim, and sometimes even when a judgment has been
entered, some options (such as an ERISA qualified plan) may still be
available.
Planning Tip: Check your state’s
laws to see what is allowed and whether the ERISA protection is limited
to bankruptcy or might include state law proceedings.
Note:
It is highly important to avoid fraudulent transfers, which are
transfers of assets not necessarily occurring with intent to defraud but
without full and adequate consideration. If there is a fraudulent
transfer claim, the advisors who helped implement the plan are likely to
be dragged in and forced to defend themselves and may be personally
liable.
Planning Tip: Clients
may misrepresent their legal difficulties, and none of us wants to
subsidize a plaintiff’s claim through the use of our own malpractice
insurance because of not asking the right questions or doing a thorough
discovery. An excellent practice is to have in your file a solvency
certificate from your client in which the client represents to you in
writing that their net worth is a positive number and that the planning
they are going to do will not render them insolvent. In some instances
it is useful to obtain permission from the client in order to do due
diligence and independently investigate to make sure you know the
information provided is accurate.
Levels of Asset Protection
Combinations
of strategies often work best in asset protection. Also, it is
important to crawl before walking. Therefore, asset protection planning
is often done by levels, usually starting at the lowest. Not every level
will be appropriate for every client.
Level 1: Exemptions
Certain
assets are automatically protected by state or federal exemptions.
State exemptions include personal property, life insurance, annuities,
IRAs, homestead, joint tenancy or tenancy by the entirety. Different
states protect assets differently and amounts of the exemptions will
vary greatly from state to state. For example, some states have an
unlimited homestead exemption; many states protect all IRAs; and many
non-community property states recognize tenancy by the entirety, which
is a great way to shelter the interests of the spouse who is not at
risk.
Federal exemptions include ERISA which covers 401(k) and
403(b) plan accounts, pensions, and profit-sharing plans. Creating and
funding qualified retirement plans for clients can provide excellent
shelters against creditors’ claims. Typically these plans must also
include one or more non-owner employee participants in order to be
covered by ERISA. Skillful pension actuaries can be very helpful with
this. Also, the Pension Protection Act protects up to $1 million in IRAs
for bankruptcy purposes.
Planning Tip:
With today’s low interest rates, defined benefit plans are becoming
popular again. Instead of the required annual fixed contributions of the
past, the IRS now allows almost as much flexibility with defined
benefit plan contributions as it does with profit-sharing plans.
Contributions can also be increased dramatically to allow for the use of
life insurance within the plan. Life insurance can be an especially
valuable asset because death benefits are not subject to income or
capital gain tax, and if done right, no estate tax.
Planning Tip:
Sometimes it is possible to convert non-exempt assets into exempt
assets. For example, cash (a non-exempt asset) can be used to pay down a
homestead mortgage and increase exempt home equity. This can be
especially useful in states with a large or unlimited homestead
exemption. Another possibility would be taking an IRA that might not be
well protected under state law and putting the assets into an ERISA
qualified retirement plan which is unreachable by third-party creditors
during the pay-in period (some portion of required minimum distributions
may be reachable by creditors).
Level 2: Transmutation Agreements (in Community Property States)
These
allow clients to convert community property assets into the separate
property of the spouse not at risk. Make sure the client is aware that
once transferred, it stays separate property and cannot become community
property again without another transmutation agreement. Separate
counsel may be needed to make this work. Plus, there may be enhanced
risk of loss in case of a divorce.
Level 3: Professional Entity Formation (PA/PC/PLLC)
State
laws will vary on this. If available, a PLLC is usually more desirable
because of the charging order limitations that prevent the creditor from
seizing any assets from the entity, limiting the creditor to only
receiving distributions that would have been made to the affected
debtor-member. In addition, the creditor may have to pay tax on any
income that is distributed under a charging order. This is often enough
to discourage a creditor from pursuing a claim. Using a jurisdiction
that allows the charging order as the sole remedy is also very useful.
Level 4: FLP/FLLC to Own and Lease Practice Assets
LLCs
can be created to own specialized or valuable equipment and/or real
estate to remove these assets from the professional practice. “Lease
back” agreements can then be created between the professional practice
and the leasing LLCs. This allows us to segregate real estate, equipment
and even securities accounts from malpractice exposure. It also allows
for good estate planning by having the leasing LLCs owned by irrevocable
trusts for the benefit of other family members.
Level 5: FLP/FLLC to Own Non-Practice Assets
Consider
the formation of a family limited partnership or family LLC in a
favorable jurisdiction that has the charging order as the sole remedy to
own non-practice assets. These would include personal use real estate,
investment accounts, cash or bank accounts, and investment real estate.
With
a personal residence in a state with limited homestead protection, one
might borrow to maximize the home mortgage and transfer the loan
proceeds to a domestic asset protection trust (DAPT), which then becomes
a member of the LLC/FLP. (It is better to have the DAPT established
first for interim protection.) The client would retain the personal
right to reside or retain a life estate in the residence.
Planning Tip: Because
home mortgages and home equity lines of credit are currently hard to
get, a qualified personal residence trust (QPRT), established as an
ongoing trust to benefit younger family members, can also be used.
However, because it is a self-settled irrevocable trust, some states
have limitations that can reduce a QPRT’s effectiveness for asset
protection. Also, the funding of a QPRT when there is a known claim
could be considered a fraudulent transfer.
Level 6: Domestic (U.S.-Based) Asset Protection Trusts
Non-practice
or leasing LLC assets can be transferred to a DAPT before any claim
arises. Having a multi-member LLC increases the charging order
protection. There are some issues with Level 6 planning, and it is
important to disclose these to clients. For example, in a state that
does not recognize self-settled irrevocable trusts the creator of the
trust cannot be a beneficiary. In that case, the spouse and children
would be the initial beneficiaries; a flight provision might be included
so the assets could go to another jurisdiction; and a trust protector
would probably be named to oversee the trustee, change the trustee,
direct the trustee to move the trust to another jurisdiction, and even
be able to decant and move the assets to another trust for the benefit
of the same beneficiaries.
The alternative is to establish the
trust in a jurisdiction that allows the grantor to be a discretionary
beneficiary. (Alaska, Delaware, Nevada and Wyoming are popular.) Each
state has its own rules that will need to be satisfied. For example, the
trustee may be required to be sited in that state and some of the trust
assets may need to be held in that jurisdiction. Associating local
counsel in the chosen trust jurisdiction may be appropriate.
Planning Tip: A
trust can be designed so that transfers to it are, for estate tax
purposes, completed or incomplete gifts. Incomplete gifts are included
in grantor’s estate for estate tax purposes and get a basis adjustment
at death. Be sure to determine what is best in each case.
Level 7: Offshore Asset Protection Trusts
These
are established under the laws of a foreign jurisdiction. (The Cook
Islands, Bahamas, Bermuda and the Channel Islands are all popular
choices.) With an offshore trust, the assets are in the hands of a local
trustee and are outside the reach of any U.S. court. However, there may
be tax issues. Also, if the court orders the assets repatriated and
they can’t be, the client could be cited for contempt and even jailed.
Funding the Asset Protection Plan
The
advisors independently and collectively will make a list of the assets
and determine where they need to go. It can easily take six months to a
year to fully fund a comprehensive asset protection plan, and it’s
usually done in steps and pieces. During the funding process, it’s very
important to keep the client informed and keep the advisors on a
timeline.
Planning Tip:
Because clients are often living into their 90s, the plan will need to
be flexible to accommodate changes over 20 or more years. An asset
protection trust is irrevocable, but ideally it can also be changeable.
That’s where the trust protector comes in.
Conclusion
Asset
protection planning is a valuable, challenging and rewarding area in
which the advisor team has many opportunities to work together for the
benefit of the team members and their clients.
To comply
with the U.S. Treasury regulations, we must inform you that (i) any U.S.
federal tax advice contained in this newsletter was not intended or
written to be used, and cannot be used, by any person for the purpose of
avoiding U.S. federal tax penalties that may be imposed on such person
and (ii) each taxpayer should seek advice from their tax adviser based
on the taxpayer's particular circumstances.
For professionals' use only. Not for use with the general public.