By Samir Dahman
A common question from clients is: how do I protect my assets, usually from a lawsuit?
- Get liability insurance
- Max out your retirement accounts
- Compartmentalize assets through LLCs
- Create an asset protection trust
The key to asset protection is that you absolutely must do it before you need it (i.e., before someone comes looking for money). Otherwise, none of these solutions will help. The time to start thinking about and preparing these strategies is now.
Insurance is paying a little bit of money over time to a company as a premium for that company taking on a future risk which you are worried about. Most insurance policies pay for the loss and also for lawyers to defend against that loss. There is insurance for almost any risk one could imagine. Consider employee liability practices insurance (EPLI). A typical EPLI policy will cover the defense of and payment of employee claims for wrongful termination, sexual harassment, discrimination, invasion of privacy, false imprisonment, breach of contract and emotional distress. For professionals, such as doctors, lawyers and accountants, malpractice insurance is usually a requirement, but the question becomes do you have enough? In general, premiums usually increase marginally with greater coverage, so it doesn’t hurt to be over-insured.
Another benefit of insurance is that you are paying only for what you want to do (i.e., guarding against a loss). It is the most direct way of addressing the potential problem. Unlike most other asset protection strategies, insurance does not require giving up anything other than the risk premium to obtain the desired protection.
The downside of insurance is that you need to know in advance precisely what risk you are guarding against. Complicating matters is that insurance companies have a vested financial interest in not paying claims because it reduces their profits. This often happens when there is a debate about whether or not a claim is covered by the insurance policy. It is a good idea have an annual insurance review by not only your insurance professional, but also by your attorney and accountant.
Once you have obtained the insurance coverage needed to cover the risks that you are concerned about, the question becomes how do you protect your assets against unforeseen risks? This is where retirement accounts come in. In addition to tax benefits, retirement accounts are shielded from creditors up to various limits. All retirement accounts provide at least $1 million exemption from creditors, and assets in employer-sponsored plans, such as 401(k)s, 403(b), 457, SEP IRAs, SIMPLE IRAs, governmental and church plans have unlimited protection from bankruptcy. The downside to putting money in retirement accounts is that you give up access to those funds now, or face steep penalties to withdraw funds, until you turn at least 59.
Limited Liability Companies (LLCs)
Think of your total assets like a ship sailing the seas. If those assets are in separate compartments in the ship’s hold (just not the Titanic), then the ship will stay afloat even if one compartment gets a hole in it. But if the ship is an oil tanker with just one big compartment, a hole anywhere in the hull will cause all of the assets to leak out and the ship will sink. Creating LLCs for your various equity holdings is like creating compartments in a ship. Owners of LLCs are not personally liable for the debts of the LLC, unless they sign personal guarantees. For example, if an LLC takes out a line of credit that the owners do not personally guarantee and the LLC is not able to repay the line of credit, then the owners are not personally liable for repaying the line of credit. Further, any other assets the individual owner may hold, such as other LLCs or other personal assets, are not liable for that debt. In the ship analogy, only the one compartment would be compromised while the rest of the compartments would stay protected.
LLCs are easy to set up and very flexible when it comes to management and how profits are distributed. LLC owners need to register with the Secretary of State, create an operating agreement, maintain corporate formalities, not comingle funds and take similar measures so the LLC’s “corporate veil” does not get pierced, in which case the owner could be held personally liable.
Asset Protection Trusts
Once you’ve purchased insurance for everything you can think of, maximized your retirement contributions, compartmentalized your equity stakes into LLCs and you still have exposed assets, the next step is to set aside a portion of your assets into an asset protection trust (APT).
APTs are designed to shield a person’s assets from all but a few claims of creditors. They are relatively easy to set up and maintain, but the hook is that you have to give up control of the assets in the APT to get the protection. A handful of states, including Ohio, as well as offshore countries offer APTs. Ohio’s APT statute only requires the person setting up the trust to give up a little control for the benefit of protection.
Here are the highlights:
- Creditors have a short period of time to make claims against your APT assets—18 months in many cases—after your property has been transferred to the trust;
- You can be a beneficiary of your own APT, live in a home owned by the APT and even keep the power to withdraw up to 5% of trust assets each year;
- Although you can’t be the trustee of your APT, you do retain significant power over distributions, including the power to veto a distribution from the trust; and
- If you don’t like your trustee’s decisions regarding management or distributions, you have the power to change trustees.
Because this post is meant as an overview of asset protection strategies and because LLCs and APTs are powerful and complicated legal tools in practice, please contact Samir Dahman at firstname.lastname@example.org or 614.427.5750 or any of the Estate Planning attorneys at Kohrman Jackson & Krantz to set up a time to discuss how we can best help.