Wealth Protection Strategies
The objective of family wealth protection is risk management, and there are several strategies to achieve that goal.
Adequate liability insurance protection may be one of the simplest and most cost effective means of family wealth protection:
- Professionals should be protected by malpractice insurance.
Businesses should carry general liability insurance.
- Fiduciaries should be bonded to provide protection of personal assets from torts committed in their fiduciary capacity.
- Families should have homeowner, automobile and umbrella liability insurance adequate to cover injury to a third party.
The goal is protection against torts — an injury to one person for which the person who caused the injury is legally responsible. Wealth protection is designed to discourage lawsuits and to promote a favorable and inexpensive settlement to all parties to the injury. It’s not intended to avoid payment of contractual obligations.
State and federal laws exempt certain individually owned assets from attachment by creditors.
Insurance policies are generally protected assets.SeekingNorth does not advocate the purchase of life insurance or annuities solely for wealth protection against creditors. These products are intended to fulfill other financial, tax, and estate planning needs; creditor protection is simply a by-product.
Annuities may be protected assets. Commercial annuities may offer more wealth protection than private annuities. A private annuity involves the transfer of property, generally to another family member, in exchange for a future stream of payments. Annuities should be purchased for financial, tax, or estate planning purposes. They may, however, offer an additional level of family wealth protection.
Qualified retirement plans, though perhaps not IRAs, are generally protected by federal and state laws.
Nonqualified retirement plans, common for highly compensated employees, are unfunded contracts between the employer and the employee. Being unfunded, amounts under these contracts are subject to the creditors of the employer and not the employee. To the extent an employee becomes vested in a nonqualified plan, those assets may be subject to creditors.
One of the most common wealth protection strategies in the transfer of wealth over generations is the use of trusts. Not every trust offers wealth protection to the person who establishes the trust or to the trust beneficiaries.
The common revocable trust — also known as a living trust — is an appropriate tool for asset management in certain circumstances, and provides probate cost savings in some states. However, it offers the creators no protection against claims by third parties. The assets held within the trust are considered by some state, and federal tax law to be owned by the trust maker.
Other types of trusts in which the grantor gives up most or all rights to the trust property generally offer legal protection of those assets. These are irrevocable trusts and may be created and become effective during the grantor’s lifetime or may be created in a grantor’s will and become effective only upon death. There are many types of trusts:
- Under federal estate tax law, bypass or credit shelter trusts may offer significant transfer-tax savings, provide income to a surviving spouse during his or her lifetime, and ensure that the trust assets reach the intended beneficiaries. Even with “portability” of a deceased spouse’s transfer tax exclusion, similar trusts may still be appropriate for tax planning and wealth protection purposes.
- Marital trusts accomplished the same goals, but lacked the transfer tax benefits.
- Children’s trusts offer wealth protection in the event of the child’s death or divorce. Trusts for the benefit of grandchildren may have significant generation-skipping transfer tax benefits if that tax is back in the law after 2010. Spendthrift provisions within a trust prevent beneficiaries from pledging trust assets for their own liabilities.
- Income-only trusts provide a child with ongoing income to maintain a certain standard of living while protecting the principal. Such trusts may provide for partial distribution of the principal upon the occurrence of specified events. Dynasty trusts provide wealth protection over many generations.
- Discretionary trusts provide the trustee with the authority to make distributions of trust principal for appropriate needs.
- Asset freeze trusts permit a family to fix the value of its estate and pass appreciating assets to another generation while permitting a senior generation some amount of control over trust assets. Asset freezes have significant tax consequences, however, and should only be undertaken with a close eye to the transfer tax costs.
- Special needs trusts provide for the needs of family members who are physically or mentally challenged and incapable of managing their own affairs.
- Charitable trusts provide an immediate or deferred benefit to one or more non-profit organizations, while allowing the maker to reserve certain benefit from the trust assets.
The use of trusts is generally limited only by the ability of the trust makers to articulate their desires and objectives. Trusts should be drafted to meet the unique needs of individuals and their families.
Transferring assets into a trust typically has transfer-tax implications. Therefore, trusts should only be drafted by legal counsel knowledgeable of both the legal and potential tax consequences. Choosing a trustee is important. Trusts are not for every family, but properly structured they can offer a virtually unlimited range of alternatives for family wealth protection.
Limited-liability entities such as corporations (including S corporations), limited liability companies (LLCs), professional corporations and limited partnerships offer a high degree of family wealth protection to business owners against torts.
Properly structured and operated, family limited partnerships may offer some degree of family wealth protection. One important note: Families should not allow all of their wealth to accumulate within an entity. Business failure or a lawsuit against the entity may eliminate a family’s principal assets. Removing wealth from a limited liability entity has important tax consequences, however, and should be carefully planned considering both the needs of the entity and the family.
Outright gifts to children or spouses provide no protection whatsoever for the beneficiaries’ creditors, or ensure that the assets will be used in the manner anticipated or desired by the person making the gift. A donor desiring protection of donate assets should consider trusts, legal enties, or other strategies to ensure their wealth transfer is used for its intended purposes.
SeekingNorth does not condone fraudulent asset-protection attempts to hide assets from other family members, creditors or the Internal Revenue Service. Scams abound and must be avoided at all costs. Widely touted offshore asset protection trusts are frequently ineffective, illegal and may result in criminal as well as civil legal litigation.
At SeekingNorth, we neither promote nor tolerate family transfers with fraudulent intent. Wealth protection is a function of state and federal law and should only be undertaken in consultation with ethical and knowledgeable legal counsel. This caveat having been stated, the goal of preserving and protecting an individual’s or family’s wealth is a legitimate objective.
The choice of wealth protection strategies is vast. Typically, no single technique is sufficient and the strategies can be complex. Working with knowledgeable legal counsel, we have assisted clients in designing workable, legal, and appropriate family wealth protection strategies, including the use of liability insurance, protected property, retirement planning, various forms of trusts and the selection of an appropriate type of liability protected business entity.
SeekingNorth is prepared to work with your family to achieve the same objectives.