Estate Planning & Asset Protection

Estate Planning and Asset Protection.

Often, when we plan our estate, we also protect our assets.  On one level, estate planning embodies asset protection.  We plan an estate to protect it from excess taxes, probate, litigation, and administrative difficulties.  We want it to pass to the intended parties with a minimum of expense and aggravation.  While this is a type or degree of asset protection, it is generally now what people are looking for when they speak of “asset protection.”

Asset protection goes beyond minimizing taxes and avoiding probate.  It involves preventing assets from being taken by hostile or predatory litigation. We live in a society where litigation is increasingly used. While there are circumstances where seeking intervention of the courts is appropriate and necessary, opportunistic abuses of litigation are too common. Just like locking the door to keep out common thieves, structuring our affairs to avoid theft through lawsuit is a rational self defense.  We lock up our valuables instead of leaving them laying around where a casual passerby might pick them up. We fence our yards, deposit cash in the bank, where seat belts, and close the curtains at night to prevent unwanted intrusions or injury.

We get in trouble when we assume that because we have done our estate planning, we have asset protection.  This is a dangerous assumption with serious consequences.

The Trust that Fails.

The most common estate planning device in the United States is the Revocable Living Trust.  Such trusts are the engine that drives estate planning.  A common misconception is that holding your assets in such a trust protects your assets from creditors.  It does not.  Such a trust may protect assets from creditors if it is properly structured, but you generally have to die for it to work.  Most people I work with are not willing to pay that price.  They would prefer a less extreme premium for the protection they desire.

The reason for this is simple.  It is an ancient maxim of the law that a person cannot put their assets in a self settled trust and prevent creditors from gaining access to such assets.  A “self settled trust” is one where the person creating the trust (the Grantor), places assets into the trust for their own benefit.  For centuries, this has been an ineffective means of protecting assets.  The Courts have consistently permitted creditors to exercise remedies against assets placed in such a trust.

In recent years, the so-called “domestic asset protection trust” {“DAPT”) have become popular.  The intent is to permit exactly what has been forbidden by long established law.  Namely, to allow a self settled trust to be unavailable to creditor claims.  There are several states that permit this to one degree or another.  The count is up to about 15 states, and the list varies depending on what you do or do not count.

Domestic Asset Protection Trusts work, to a degree.  There are circumstances where they are the right tool.  However, clever lawyers have also written volumes on how to defeat such trusts.  Bankruptcy courts and others hunt for work arounds to get at assets in such a trust.  Among other concerns, these trusts are easily frustrated if not properly implemented.  For example, for the assets to be protected they must generally be located in the state where that particular type of trust is permitted.  This is almost always very difficult to comply with over time.  It’s a little like expecting a car with four seat belts to protect eight passengers from a crash.  Even with seat belts, any cash is going to cause pain.

The bottom line is this:  A revocable living trust does not protect your assets.  You must have something more.

The “Something More” that Works.

For estate planning and asset protection to truly go hand in hand, there will be more structures than just a single trust.  Typically there will be layered entities including one or more Irrevocable Trust, limited partnerships, limited liability companies, corporations, debt instruments, security instruments, and other devices to secure equity and thwart the efforts of predators to attack and take.  In certain very specific situations, off shore entities may also be appropriate.  Even when the Domestic Asset Protection Trust is going to be effective, something more is advisable and prevents the most common operational failures.

In “large” estates, there will almost always be such additional entities to work with.  (The definition of a “large estate” is a moving target under the tax law.  For the individuals involved in the estate, “large” is any amount of wealth worth protecting.)  Large estates are created by people who go into business, and people who go into business generally understand and use appropriate business entities.  The asset protection derives from how such entities are put together.

The effectiveness of an entity in protecting assets is NOT the entity itself, but how that entity is owned, controlled and structured.  For example, an LLC alone does not generally protect assets, even though it has “limited liability” in the name.  For an LLC to actually be effective at protecting assets it must be managed in a way that prevents adverse parties from gaining control, and owned in a manner that prohibits third parties from becoming owners.  Among other things, this means vesting management in more than one third party manager of the right type and nature, and having more than one member.

Estate planning and asset protection are team sports.  The design, implementation and operation of an effective asset protection plan is a team effort requiring the input of the client, the legal advisor, the tax and accounting advisors, the investment advisors, and the insurance advisors.  It adds significant complexity to life, and is not for the faint of heart.  The cost of complexity and administration is a factor that must be weighed against the benefit to be gained by any asset protection plan.

All asset protection improves with age.  The earlier it is established, the more effective it will be and the less it will cost.  Last minute asset protection costs more and does not work as well.  Sometimes it does not work at all.

So What?

• If you only have a trust and you think your assets are protected, get your trust reviewed and obtain meaningful guidance on what you really have or don’t have.
• If you have a more complex estate plan and think you have asset protection, get it reviewed by someone who knows what they are doing to make sure.
• If you have a domestic asset protection trust, are all the assets located in the jurisdiction that you are claiming gives you protection?
• If you don’t have an estate plan or asset protection, ask yourself if you are comfortable with the risk.
• If you have an asset protection plan and it is not working, or its too complicated, or you don’t understand it, or you don’t know how to use it, get help.

Estate planning and asset protection are important, but they may not be what is most important.  Both estate planning and asset protection require balancing the cost of protection, including the complexity and maintenance, against the benefits obtained.  If the benefits outweigh the costs do it.  If the costs are too high for the benefits, don’t.