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Asset protection is for everyone

When many people hear the words “asset protection,” they think of billionaires with Swiss bank accounts and offshore tax havens. But in reality, asset protection is for everyone. It’s simply a series of basic techniques you can use to help ensure that the wealth you’ve accumulated stays with you and your heirs, and not someone else.

Hard-earned wealth can quickly disappear as a result of a lawsuit, a business going under, or a similar event. Asset protection techniques exist to protect you from these possibilities. You can also use them to help protect your children or other heirs from the consequences of a divorce, lawsuit, business failure, and so on.

It’s actually more important for people of moderate wealth to engage in asset protection than it is for billionaires. After all, billionaires can afford to lose a lot of money, whereas the rest of us cannot.

In fact, now that the federal estate tax affects far fewer people than it used to – the tax doesn’t even kick in unless an estate is worth over $5 million, or over $10 million for a married couple – the focus of estate planning is increasingly shifting from protecting assets from taxes to protecting assets from creditors.

So what sorts of things can you do to protect yourself?

One of the more basic forms of asset protection is insurance. If you have an auto or homeowner’s insurance policy, you’re already engaging in asset protection. The policies will protect you in many cases if a lawsuit is filed against you.

A good first step is to thoroughly review your insurance coverage every few years, and make sure you have enough. You might want to buy an umbrella liability insurance policy, which kicks in after your other policies’ coverage limits are reached. The goal should be to have enough insurance (and protect your other assets well enough) that a person who brings a lawsuit against you will simply settle with your insurance company under your policy limits, and not try to go after your home or other assets.

Life insurance can be another way to protect your heirs, because in many states a creditor cannot claim either the proceeds or the cash value of a life insurance policy. In some states, the same is true if you’re the beneficiary of a fixed annuity.

Retirement plans are another type of asset protection. Assets in a retirement plan are often exempt from creditors. However, you should be aware that the rules can vary a great deal depending on the type of plan, the type of creditor, and the state where you live.

A federal law called ERISA says that 401(k) plans are generally exempt from creditors, although there are some exceptions, such as claims for child support.

However, ERISA doesn’t apply to IRAs, SEP plans, SIMPLE plans, Keogh plans, or government plans. For these plans, the level of asset protection typically depends on state law.

Many states have broad protection from creditors, but not all. Sometimes the rules are highly complex. (In Massachusetts, for instance, IRA contributions generally are not protected from a court judgment to the extent that they exceed 7% of the person’s total income during the five years before the judgment occurred.)

Further, there are completely different rules if a person has a business setback and files for bankruptcy. For instance, rollover IRAs are generally protected in bankruptcy, but traditional and Roth IRAs are protected only up to about $1 million. And an IRA that you inherited from someone else might not be protected at all.

What this means, among other things, is that you should never just casually consolidate different types of retirement accounts. While this might make things easier in terms of recordkeeping, it could destroy or weaken your protection from creditors.

If you’re concerned about your heirs, a good way to protect them is to put assets into a trust for their benefit, rather than giving money to them directly or leaving assets to them in your will.

Many people use trusts to make sure a beneficiary who is young or financially inexperienced won’t make mistakes and quickly exhaust an inheritance. But such trusts can actually make sense for other types of heirs as well. That’s because assets in a trust might be kept out of reach of a business or lawsuit creditor or a divorcing spouse.

Can you put your assets into a trust for your own benefit, and keep them away from creditors?

That’s a good question. Some 15 states now allow trusts of this type, and people who live in other states can take advantage of them by setting up trusts in one of the 15 states. However, these states’ laws are new, and it’s still very unclear how well they will actually work to protect assets (especially for people who live outside the 15 states).

Still, while it’s not clear that these trusts will ultimately succeed, they’re one more hurdle that might discourage a creditor from going after you.

If you really want to protect your assets in this way, you might consider setting up a trust in a foreign country that offers this type of protection. Doing so is complicated and can involve a lot of regulations and paperwork, but it might be a safer bet.

Speaking of going offshore, some foreign companies offer life insurance policies with greater asset protection rules than are available in some U.S. states.

If you’re concerned about protecting your wealth, it’s a good idea to talk with a lawyer to review your potential exposure and your options. And it’s wise to do it sooner rather than later, because asset protection planning only works against future problems. In general, once a claim against you has arisen, it’s already too late to protect your assets against it.

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