Why You Need to Worry About Asset Protection Planning

At its core, asset protection planning is about keeping your money and property safe from those who might take it from you via the legal system. Commonly, people engage in asset protection planning to minimize risk of loss from potential litigation, divorce, or to protect against would be creditors.

In this article, we’ll cover asset protection strategies to consider as part of your financial planning.

What is Asset Protection Planning?

By taking advantage of various legal methods, asset protection planning can provide a variety of safeguards. These range from increased privacy to practically removing assets from the purview of the courts, making them essentially judgment-proof.

What Asset Protection Planning is Not

Sure, asset protection can provide privacy and shielding of assets from would-be creditors and the like. However, it is not a way to hide your assets from the government.

Despite common misconceptions, asset protection planning is not about avoiding the IRS or evading taxes. Properly structured asset protection plans are always tax neutral. If someone you are working with suggests otherwise, or uses potential tax savings as a selling point for the asset protection plan, this is a huge red flag.

Such plans generally use pass-through entities. According to the Tax Foundation, these entities, such as S Corps and LLCs, are called pass-through because “the profits of these [entities] are passed directly through the business to the owners and are taxed on the owner’s individual income tax returns.”

Who is Asset Protection Planning for?

I was talking with one of my colleagues, an estate planning attorney, recently about how many of his clients are interested in asset protection planning. He had an interesting comment on the topic: “All my clients are concerned about asset protection. The only thing is, not all of them think of it that way.”

For example, many clients are not particularly worried about lawsuits and potential creditors. But  they may have other concerns such as what would happen to their assets in the case of a divorce, or how they can ensure that their legacy is protected once they are gone.

Generally, asset protection planning is just one component of a larger overall estate plan, or financial plan. That being said, it is important to ensure that one’s asset protection planning fits in with one’s overall financial and estate planning goals.

Related: How to Avoid Estate Taxes on Life Insurance Proceeds

When and Why to Consider Asset Protection Planning

There is no specific event or financial threshold (such as $X net worth) that creates an absolute need for asset protection planning. Generally speaking, most people will benefit from some level of protection, regardless of their financial tier.

The only wrong time to consider guarding assets is at the last minute, after one’s assets are already in jeopardy. That could be because of a recently filed lawsuit, judgment, or divorce. Regardless, it won’t do much good at that point.  As with all legal organization (or planning for anything really), it must be done in advance in order to be effective.

So what are some of the reasons to consider asset protection planning?

Litigation

It is no secret that, especially here in the United States, we live in an ever-more-litigious society. As an attorney, I often get asked some variation of the question, “Can I get sued for that?” As a matter of course, I always begin my answer the same way. The reality is that, generally speaking, anyone can sue you at any time for any reason. Of course, whether any particular lawsuit will have merit is another issue entirely.

Another unfortunate reality is that lawsuits are expensive. The cost of defending against a lawsuit, even a frivolous one, can add up very quickly. Throw a judgment in on top of that, and even a reasonably well-off individual can find themselves in financial dire straits.

Divorce

An unfortunate reality of marriage is that it can sometimes end in divorce. Most people don’t go into marriage contemplating how poorly it could end. So many times, planning for that possibility gets overlooked.

Depending on how a couple structures their finances and estate, ex-spouses and/or children may end up with assets or property that the other spouse no longer wants them to have. By taking steps to plan ahead of time, such situations can be avoided.

Creditor

Asset protection planning can also provide protection from future creditors. It should go without saying, but asset protection is not to be used as a means to defraud current creditors or to avoid genuine financial obligations. That being said, it can be advantageous to structure one’s assets in ways that would keep them safe from potential creditors.

Examples of Basic Asset Protection Planning

You have likely begun doing asset protection planning already. You just may not even realize it.

Insurance

One of the most basic forms of asset protection comes in the form of liability insurance. If you own a car, house, or business, you likely have liability insurance in place. This is often the first line of defense in asset protection, as it is relatively affordable and easy to acquire.

Such insurance serves the purpose of providing a barrier between a potential liability and your assets. Many people have experienced this firsthand in the context of an automobile accident. Where one driver is found to be “at fault” (liable), that driver’s insurance, rather than the driver himself, often bears the costs.

Additionally, professionals such as doctors and lawyers may also have basic asset protection in place in the form of malpractice or errors & omissions insurance. These help guard against potential claims related to their profession.

Business Entities

Use of business entities such as LLCs or S Corps serve to keep business assets and liabilities separate from personal assets and liabilities. They can also provide a layer of asset protection and privacy. The privacy benefits alone can serve a useful function, which is particularly true with real estate.

For example, consider two rental property owners. Nick, who owns 123 Main Street (a single family residence in his own name), and Luke, who owns 456 Park Street (a comparable, single family residence inside an LLC).

Now imagine Peter, a potential Plaintiff, was looking to sue Nick. Peter’s attorney (especially if this attorney works on a contingency fee basis) would likely perform a public records search to see if Nick owned any assets, which could be used to satisfy a judgment.

In other words, Peter’s lawyer would look to see “how deep” Nick’s pockets were to see if Peter’s case would be worth taking. Seeing Nick’s rental property as an asset, Peter’s attorney may decide to pursue the case.

Contrast that with Luke’s situation. Luke’s property is actually owned by Luke’s LLC, “Park Street Holdings.” In this case, a public records search for Luke would likely not reveal Luke as the owner of any rental property. Without an obvious asset to target, Peter’s lawyer may reconsider his case against Luke.

As its name suggests, a limited liability company (LLC), can serve to limit the liability of the LLC’s members. Generally speaking, properly maintained LLCs can also shield the owner’s outside assets from claims arising within the LLC.

Continuing the example above, say one of Luke’s tenants at 456 Park Street fell on the property and was injured. Due to the LLC structure, the tenant may be able to make claims against the asset inside the LLC (456 Park). However, they could not make claims against Luke’s personal residence, which is owned by Luke in his own name.

Closing Thoughts

Asset protection planning covers a wide spectrum of tactics and strategies. For most people, the use of liability insurance and/or business entities may be enough to provide a reasonable level of safety security for their assets.

For those with a higher net worth or who desire a greater level of protection, more advanced planning strategies exist. These include domestic asset protection trusts. Some particularly complex scenarios even make use of offshore bank accounts, business entities, and trusts. There are numerous options and methods to keep your assets safe and secure.

In what ways have you protected your assets? Have you ever had an asset threatened or impacted, where you had wished you’d taken measures to protect it beforehand?

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