1. Sentinel Solutions
530 Fifth Avenue
11th Floor
New York, NY 10036
212-536-6150
cschneider@sentinelsolutions.com
www.sentinelsolutions.com
Asset Protection
December 03, 2012
Page 1 of 10, see disclaimer on final page
2. Asset Protection
Introduction • Business creditors, including employees
and former employees, governmental
If you haven't done any asset protection agencies, suppliers, customers, partners,
planning, your wealth is vulnerable to potential shareholders, and the general public
future creditors and, should the worst happen, • Creditors of other individuals, where you
you could lose everything. have cosigned or guaranteed obligations
for those individuals
Lawsuits, taxes, accidents, and other financial • Marital or other live-in partners
risks are facts of everyday life. And though
you'd like to believe that you're safe,
If you haven't done any misfortune can befall even the most careful
Asset Protection Techniques
asset protection planning, person. What can you do? First, identify your
your wealth is vulnerable to potential loss exposure, then implement There are three basic asset protection
potential future creditors strategies that are designed to help reduce techniques: insurance, statutory protection,
and, should the worst and asset placement. None of these
happen, you could lose
that exposure without compromising your
other estate and financial planning objectives. techniques is a complete solution by itself, but
everything. may make sense as one limited component of
an asset protection plan.
First, a word about fraudulent
transfers Insurance
Part of your overall asset protection plan might The simplest way to cope with risk is to shift
include repositioning assets to make it legally the risk to an insurance company. This should
difficult for potential future creditors to reach be your first line of defense. Before you do
them. This does not, however, extend to anything else, review your existing coverage.
actions that hide assets or defraud creditors. If Then consider purchasing or increasing
a court finds that your asset protection plans coverage on your insurance policies as
were made with the intent to defraud, it will appropriate. You should be adequately
disregard those plans and make the assets insured against:
available to creditors. How can you avoid
running afoul of the fraudulent transfer laws? • Death and disability
The simplest way to cope • Medical risk, including long-term care
with risk is to shift the risk • Make sure your plans are made for
to an insurance company. legitimate business purposes or to • Liability and property loss (both personal
This should be your first accomplish legitimate estate planning and business)
line of defense. objectives • Other business losses
• Carefully document the legitimate business
and estate planning purposes of any Statutory protection
arrangements you make
• Put your plans into effect before you have Creditors can't enforce a lien or judgment
any problems with creditors against property that is exempt under federal
• Do not implement a plan at a time when a or state law. While exemption planning can't
lawsuit is imminent or pending or at a time offer total protection, it can offer some shelter
when you have an outstanding debt that for certain assets.
you believe you may be unable to pay
Both federal and state laws govern whether
property is exempt or nonexempt in
Where the dangers lie nonbankruptcy proceedings (separate federal
and state laws govern whether property is
Unexpected liability can come from just about exempt or nonexempt in bankruptcy
anywhere: proceedings). Generally, you can choose
whether the federal exemption or the state
• The IRS and other tax authorities exemption applies. When looking at
• Accident victims, including victims whose exemption laws, be sure to find out how much
injuries were caused by the actions of of an exemption is allowed for a particular type
minor children or employees of property--it may be completely exempt, or
• Doctors, hospitals, nursing homes, and exempt only up to a certain amount or
other health-care providers restricted in some way. Types of property
often receiving an exemption include:
• Credit card companies
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3. • Homestead (principal residence) (e.g., organizational meetings), has its assets
• Personal property drained (e.g., unreasonably high salaries paid
to shareholder-employees), is inadequately
• Motor vehicle funded, or has its funds commingled with
• IRAs, pension plans, and Keogh plans shareholders' funds.
• Prepaid college tuition plans
Caution: A number of issues should be
• Life insurance benefits and cash value
considered when selecting a form of business
• Proceeds of life insurance entity, including tax considerations. Consult an
• Proceeds of annuities attorney and tax professional.
• Wages
Limited liability companies (LLCs) and
Tip: In those jurisdictions that recognize partnerships (LLPs and FLPs)
ownership by tenancy by the entirety (TBE),
creditors of the husband or creditors of the An LLC is a hybrid of a general partnership
wife cannot reach TBE assets. and a C corporation. Like a partnership,
income and tax liabilities pass through to the
Asset placement members, and the LLC is not double-taxed as
a separate entity. And, like a C corporation, an
Asset placement refers to transferring legal LLC is considered a separate legal entity that
ownership of assets to other persons or can be used to own business assets and incur
entities, such as corporations, limited debt, protecting your personal assets from
partnerships, and trusts. The basis for this other nontax claims against the LLC.
technique is simple--creditors can't reach
property that you do not own or control. Professionals (e.g., doctors, lawyers, and
accountants) face liability for damages that
Shifting assets to the spouse who is less result from the performance of their
exposed to claims professional duties. While no business
structure will protect you from personal liability
If you have high exposure to potential liability for your professional activities, an LLP will
because of your occupation or business, it protect you from the professional mistakes of
may be advisable for you to shift assets to your partners. That is, if one of your partners
your spouse. Your spouse would retain the is sued, and the LLP is also named in the
assets that are subject to the exposure as his lawsuit, any malpractice judgment is the
or her separate property, and you would retain personal liability of the partner who's been
assets that enjoy statutory protection, such as sued, but a business liability for you and the
the homestead, life insurance, and annuities, other partners. Your personal assets aren't at
as separate property. Furthermore, the shifting stake if your partner commits malpractice,
of assets to a spouse or children may help although your investment in the business may
accomplish other estate planning goals. still be at risk.
Caution: To avoid complications in the event An FLP is a limited liability partnership formed
that your marriage ends in divorce, both you by family members only. At least one family
and your spouse should agree to the division member is a general partner; the others are
of assets in writing. This is especially limited partners. A creditor can't obtain a
important in community property states. judgment against the FLP--it can only obtain a
charging order. The charging order only allows
C corporations the creditor to receive any income distributed
by the general partner. It does not allow the
If you own a business and aren't already a C creditor access to the assets of the FLP. Thus,
corporation, changing your business structure a charging order is not an attractive remedy to
to a C corporation will make it a separate legal most creditors. As a result, the limitation to
entity in the eyes of the law. As such, a C seeking a charging order can often convince a
corporation owns the business assets and is creditor to settle on more reasonable terms
responsible for all business debts. Thus, than might otherwise be possible.
incorporating your business separates your
business assets from your personal assets, so Protective trusts in general
your personal assets will generally not be at
risk for the acts of the business. A protective trust can protect both business
and personal assets from most creditors'
Caution: The limited liability feature may be claims. A trust works because it splits
lost if, for example, the corporation acts in bad ownership of trust assets; the trustee has
faith, fails to observe corporate formalities equity ownership and the beneficiaries have
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4. beneficial ownership. Essentially, a protective be able to reach assets held in a trust, a court
trust works like this: must have jurisdiction over the trustee or the
trust assets. Where the trust is properly
Example: Harry would like to leave property established in a foreign country, obtaining
to Wendy. However, Harry is afraid that his jurisdiction over the trustee in a U.S. court
creditors might claim the property before he action will not be possible. Thus, a U.S. court
dies and that Wendy will receive none of it. will be unable to exert any of its powers over
Harry establishes a trust with both himself and the offshore trustee.
Wendy as the beneficiaries. The trustee is
instructed to allow Harry to receive income So, the creditor must commence the suit in the
from the trust until Harry dies and then to offshore jurisdiction. The creditor can't use its
distribute the remaining assets to Wendy. The U.S. attorney; it must use a local attorney.
trust assets are then safe from being claimed Typically, a local attorney will not take the
A protective trust can by Harry's creditors, so long as the debt was case on a contingency fee basis. Therefore, if
protect both business and entered into after the trust's creation. a creditor wants to pursue litigation in the
personal assets from most offshore jurisdiction, it must be prepared to
creditors' claims. A trust Under these circumstances, any of Harry's pay the foreign attorney up front. To make
works because it splits
ownership of trust assets;
creditors would be able to reach assets in the matters even less convenient, many
the trustee has equity trust only to the extent of Harry's beneficial jurisdictions require the creditor to post a bond
ownership and the interest in the trust. Say that Harry's interest in or other surety to guarantee the payment of
beneficiaries have beneficial the trust is a fixed income distribution each any costs that the court may impose against
ownership. month in the amount of $1,000. Assuming the creditor if it is unsuccessful. Taken as a
Harry's creditors obtained a judgment, they whole, these obstacles have the general effect
would only be entitled to the $1,000 per of deterring creditors from pursuing action.
month.
Domestic self-settled trusts
Irrevocable trusts
The laws in Alaska, Delaware, Nevada, and a
As the name implies, an irrevocable trust is a few other states enable you to set up a
trust that you can't revoke or change. Once self-settled trust. Alaska was the first state to
you have established the trust, you can't enact such an anti-creditor trust act, and
dissolve the trust, change the beneficiaries, Delaware quickly followed. Hence, this type of
remove assets from the trust, or change its trust is often called an Alaska/Delaware trust
terms. In short, you lose control of the assets (sometimes also referred to as a domestic
once they become part of the trust. But, asset protection trust, or DAPT). A self-settled
because the assets are out of your control, trust is a trust in which the person who creates
they're generally beyond the reach of creditors the trust (the grantor) can name himself or
too. You may further protect those assets from herself primary, or even sole, beneficiary.
your beneficiaries' creditors by using special These trusts give the trustee wide latitude to
language (known as a spendthrift clause) in pay as much or as little of the trust assets to
the trust. any or all of the eligible beneficiaries as the
trustee deems appropriate. The key to this
Caution: Unlike an irrevocable trust, a type of protective trust is that the trustee has
revocable trust provides the assets in the trust the discretion to distribute or not distribute the
with absolutely no legal protection from your trust property. Creditors can only reach
creditors. property that the beneficiary has the legal right
to receive. Therefore, the trust property will
Offshore (foreign) trusts not be considered the beneficiary's property,
and any creditors of the beneficiary will be
It's possible to transfer assets to trusts that are unable to reach it.
formed in foreign countries (certain countries
are preferred). While the laws of each country Caution: Domestic self-settled trusts may not
are different, they share one similarity--they be as effective as a foreign trust, because a
make it more difficult for creditors to reach judgment from an individual state must be
trust assets. honored by another state under the United
States Constitution.
Here's how it works: In order for a creditor to
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5. State Homestead Laws
The origin of state homestead Generally, the property you homestead must
be property that you own and occupy as your
laws primary residence. In most states, property
eligible for homestead law protection includes
The federal Homestead Act, which was a single-family or multifamily home (and its
enacted in 1862, offered free 160-acre parcels lot), a condominium unit, or a mobile home.
of land to anyone willing to settle on them.
After five years, these "homesteaders" would
become the owners of the land, as long as Protection limits
certain conditions were met (such as building
a house and living on the property). Though Homestead laws exempt from attachment a
this act was repealed in 1976, many states certain amount of the equity value in the
have enacted their own homestead laws. If homestead property. A few states offer
your state has one, it may protect some or all unlimited protection; in Florida, for example,
of the equity in your home against certain the homestead law completely exempts a
creditor claims. multimillion-dollar mansion's total value from
attachment by certain unsecured creditors.
Caution: A homestead filing will protect your Most states, however, assign a limit to the
home from most debts (including judgments) amount of protection offered by their
that arise after the homestead becomes homestead laws. These limits vary widely. For
effective. It generally will not protect a home instance, an individual homeowner in
from debts incurred before the homestead California may be eligible for only $75,000 in
status attaches. exemption protection, while the same
homeowner in Massachusetts would receive
Caution: While the homestead laws in some $500,000 in protection.
states may substantially protect your
residence from unsecured creditor claims, Example: You are a single individual, your
even through a bankruptcy filing, this is not home is valued at $450,000, and it carries a
always the case. You should consult an mortgage lien of $200,000 against it. Your
attorney about the protection offered by your equity is then $250,000 ($450,000 -
state's homestead laws and other asset $200,000). If you live in California, you may
protection strategies. use the homestead law there to protect
$75,000 of that equity, leaving $175,000
unprotected. However, if you live in
What homestead laws do Massachusetts, your state's homestead
declaration exempts all $250,000 of your
State homestead laws vary widely from state equity from unsecured creditor attachment.
to state. Some offer property tax relief or other
specific tax considerations to real estate Homestead laws do not automatically prevent
owners. Generally speaking, however, most a forced sale of your primary residence to
state homestead laws allow you to exempt a satisfy a creditor claim. In the example above,
specified amount of the equity in your if you live in California, the sale of your home
homestead property from attachment and could be forced to satisfy such a claim, since
seizure efforts by certain unsecured creditors. the creditor could be paid from the sale's
The intent of these laws is to ensure that you equity proceeds over and above the amount
won't be forced to sell your home if you're the homestead law exempts from attachment.
otherwise unable to pay certain debts. If you live in Massachusetts, however, the
homestead law would exempt up to $500,000
How to obtain protection of a sale's equity proceeds from attachment; in
this case, there would be no point in a creditor
The process of acquiring homestead law forcing a sale of the property to satisfy a claim.
protection varies from state to state. Some
states require you to live in the state for a Caution: If the equity value of your property
certain length of time before you become increases over time (as your mortgage
eligible for homestead law protection. In a few balance decreases and/or property values
states, coverage is automatic. In most states, rise), it may exceed the exemption protection
however, someone who is named on the deed allowed by your state's homestead law. In that
to the property and who lives there must file a event, should a forced sale occur to satisfy a
notarized declaration of homestead form with creditor claim, the homestead law would
a local government office, such as a registry of protect some, but not all, of the equity in your
deeds. home.
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6. Some creditors are not subject your home, particularly if you have substantial
equity in it.
to homestead law protections
Example: Jimmy, a single individual, lives in
Homestead laws do not protect your home Georgia, where he owns a modest home
from all creditors. Generally, these laws valued at $100,000. When he files for Chapter
exempt a portion of the equity in your principal 7 bankruptcy against $97,000 in unsecured
residence from attachment by creditors to debt, he is required to do so under the
whom you owe unsecured debts (e.g., medical Georgia exemption laws, which allow him to
bills, credit card balances, and personal keep a homestead worth only $5,000. Since
loans), even if the creditor has obtained a the value of his home exceeds that amount,
court judgment against you. he must sell his home, keep $5,000 of the sale
proceeds as allowed by the state exemption
A Note of Caution Other debts are simply not subject to the laws, and distribute the remainder to the
exemption protection homestead laws offer. creditors named in his bankruptcy petition to
For bankruptcy filings made on
or after October 17, 2005,
These include: partially satisfy their claims.
there is a two-year residency
requirement for using state • Mortgages, second mortgages, home Meanwhile, George, a single individual, lives
homestead exemptions. equity loans or lines of credit secured by in Texas, where he owns a ranch valued at
Specifically, to use a state's the property $750,000. When he files for Chapter 7
exemption, you must have • Mechanic's liens for labor and/or materials
resided there for 730 days
bankruptcy against $325,000 in unsecured
(about 2 years) prior to filing
provided to construct, alter, improve, or debt, he is allowed to elect either the federal
bankruptcy. If you resided in repair the property or the state exemption laws. Since Texas
more than one state during this • Federal, state, or local income taxes; homestead law exempts a residence of
730-day period, the governing property taxes; or other assessments unlimited value, George chooses to file under
exemption law will be the state the state exemption laws. He is not required to
in which you resided for the • Debts owed to government agencies, such
sell his ranch to raise money to satisfy the
majority of the 180-day period as federal student loans or state Medicaid
creditors named in his bankruptcy petition.
(about 6 months) preceding the liens
730-day period. • Court-ordered support of a spouse or minor For bankruptcy filings made on or after April
children 20, 2005, the Bankruptcy Abuse Prevention
and Consumer Protection Act of 2005
Homestead laws and imposes certain restrictions on state
bankruptcy homestead exemptions.
State homestead laws can profoundly affect • Even if your state allows for a larger
whether or not you may keep your home in exemption, you may only exempt up to
bankruptcy. In bankruptcy, you are not $146,450 (as of April 1, 2010) if you
required to surrender exempt property to acquired your home within the 1,215-day
satisfy the claims of creditors. The federal period (about 3 years, 4 months) prior to
government allows individuals an $21,625 (as filing bankruptcy. This limit does not apply
of April 1, 2010) exemption in bankruptcy for to equity you rolled over from one home to
real estate used as a primary residence. This another within the same state during this
federal exemption can vary significantly from period.
what you may be allowed to keep under your • If you made an addition to your home in the
state's exemption laws. 10-year period prior to filing with the intent
to hinder, delay, or defraud creditors, your
Some states require you to follow their allowable exemption is reduced by the
exemption laws when filing for bankruptcy. In value of the addition.
such cases, you'll have no choice about the • An absolute cap of $146,450 applies if you
amount of your home exemption; you'll be (a) have been convicted of a felony that
able to keep what your state's homestead law demonstrates that the bankruptcy is
allows. Other states allow you to choose "abusive," or (b) owe a debt arising from
between the federal and state exemption laws. violations of securities laws, fiduciary fraud,
In states where you have a choice, your racketeering, or crimes or intentional torts
decision about how to file for bankruptcy may that caused death or serious bodily injury in
turn in part on which set of rules allows you to the preceding five years. This provision,
keep the greatest amount of your home's however, will not apply if the homestead is
value. In such cases, if your state homestead reasonably necessary for your support and
law allows a more liberal home exemption the support of your dependents.
than the one allowed by the federal law, filing
for bankruptcy under the state exemption laws
may increase the probability that you'll keep
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7. How Insurance Preserves Assets
Type of Insurance How Does It Work?
Life insurance Provides the beneficiaries of your life insurance
policy with funds upon your death so that your
assets will not need to be used to pay final
expenses and estate taxes.
Disability income insurance Pays benefits to replace part of your earned
income while you can't work due to illness or
injury so that you continue to meet your
financial obligations (e.g., mortgage).
Health insurance Pays medical expenses incurred as a result of
an illness or injury, so that you do not need to
use your assets to pay for them.
Long-term care insurance Pays for certain in-home and nursing home
care expenses, preserving your assets for your
heirs.
Homeowners insurance Pays for certain property damage and losses
so that the property can be repaired or
replaced without you having to use other
assets to do so. Also covers certain liability
claims.
Automobile insurance Pays for damage to your automobile so that
you can fix or replace it
(collision/other-than-collision coverage). Also
covers certain liability claims (liability
coverage).
Umbrella liability insurance Provides liability protection above and beyond
basic coverage provided by homeowners and
automobile policies.
Business or professional insurance Pays for certain business losses (e.g., property
damage, business interruptions, liability
claims).
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8. How C Corporations, Limited Liability Companies,
and Limited Liability Partnerships Protect
Personal Assets
How an Irrevocable Trust Protects Assets
Page 8 of 10, see disclaimer on final page
9. How a Domestic Self-Settled Trust Protects Assets
How an Offshore (Foreign) Trust Protects Assets
Page 9 of 10, see disclaimer on final page
10. Disclosure Information -- Important -- Please Review
Securities, Investment Advisory Services and Financial Planning Services through qualified Registered
Representatives of
MML Investors Services, LLC., Member SIPC. Supervisory Office: 530 Fifth Ave., 14th Fl. ? New York, NY
10036 ? 212.536.6000
Sentinel Solutions, Inc. is not an affiliate or subsidiary of MML Investors Services, LLC or its affiliated
companies.
Sentinel Solutions
530 Fifth Avenue
11th Floor
Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The New York, NY 10036
information presented here is not specific to any individual's personal circumstances. cschneider@sentinelsolutions.com
212-536-6150
To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be
used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should
seek independent advice from a tax professional based on his or her individual circumstances.
These materials are provided for general information and educational purposes based upon publicly
available information from sources believed to be reliable—we cannot assure the accuracy or completeness
of these materials. The information in these materials may change at any time and without notice.
Page 10 of 10
December 03, 2012
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2012