“Lawsuit: A machine which you go into as a pig and come out of as a sausage.”
~Ambrose Bierce, American editorialist and satirist.
Last week, our Part One post of “Protecting Assets from Lawsuits and Judgments” described the many kinds of personal and professional liability that can make somebody susceptible to a judgment or lawsuit. We also gave tips on protecting your assets from judgments or lawsuits with 1), proper insurance, and 2), business entities.
This week, we’ll detail more strategies to protect your cash, your investments, and your home from lawsuits and creditors. (Protecting your future income is also important, but another post for another day).
3. Protect Your Cash Stash: Save Money Safely
A savings account is NOT a safe place to store your cash! (Even without creditors and lawsuits, we have argued that a bank account is NOT the safest place to put your money.) Bank accounts are often reported to the IRS and can be accessed by creditors – even without your foreknowledge, in some situations. Saving a lot of money in traditional bank accounts can actually make you a target!
Three financial vehicles often used to keep cash safe from harm are Retirement Accounts, Cash Value Accounts (part of a whole life insurance policy), and Annuities. Let’s take a look at each.
Retirement Accounts. Many people are aware that qualified retirement accounts such as 401(k)s and IRAs are (usually*) protected from creditors and lawsuits up to $1 million, as provided for in the 2005 Bankruptcy Reform Act. These can be good choices for a portion of your savings when you are nearing 59-1/2 and/or if you receive an employer match.
However, if you:
- don’t receive matching funds
- receive very limited matching funds (e.g.: 25% match to 3% of income…)
- are decades from 59-1/2 (when qualified funds can begin to be accessed)
- are a business owner who may have a future need for business capital
- don’t have access to solid, non-volatile investments through your employer’s retirement plan, or
- have inadequate cash reserves (a year’s wages should be just the start),
then socking away your cash where you can’t access it is unwise and risky!
Just because you are told again and again to “max out your 401(k)” doesn’t mean it’s good advice. Whether it’s home equity or a qualified retirement plan, putting your cash where YOU can’t get to it may make it safer from lawsuits, but it doesn’t do enough to increase YOUR financial security in the meantime. (See our articles on “Financial Flexibility: Saving Too Much in All the Wrong Places” and “Saving Right: Is Your Emergency Fund Prepared for Opportunities.” for more.)
(And we’re not sure that plaintiffs are your biggest worry when you could lose 30, 40, even 50% of your retirement account in a single year to “the market.”)
So… where ARE your assets safe from lawsuits and creditors?
Whole Life Cash Value Accounts. Cash value accounts in a properly structured whole life insurance policy are (usually*) one of the safest places you could store your cash. (This type of insurance is also known as participating whole life, dividend-paying whole life, mutual life insurance, and permanent insurance.)
Cash value accounts typically provide an internal rate of return many times higher than what banks provide, usually 4% or higher (depending on your age), with even greater safety and no risk of principle as in market-driven vehicles.
There are other tremendous benefits as well, such as tax-advantaged treatment (gains are not taxed as long as policy is maintained), and the ability to use funds or borrow against them with no qualifying hoops to jump through (an essential benefit for entrepreneurs and investors). And in most states*, cash value accounts are protected from judgments, lawsuits, and even from IRS knowledge.
Annuities. A type of investment that return a steady, guaranteed income, annuities are (typically*) protected against lawsuits and creditors. Annuities are also a life insurance product, and as such, they are protected against market fluctuations. When someone purchases an annuity, they typically exchange a sum or money for regular payments guaranteed for a certain length of time, or, in some cases, for the remainder of a lifetime.
While annuities are extremely safe (in most states) from plaintiffs or creditors, they don’t have the flexibility and benefits of whole life insurance. (For reasons a bit beyond the scope of this article, we don’t often recommend annuities for our clients. We’d be happy to discuss why and offer alternatives in a complimentary consultation.)
*We say “usually” or “most states” because laws do vary – sometimes significantly – from state to state. Before you commit to any asset protection strategy, it is important to verify the specific laws in your state or jurisdiction as to which assets (and how much) are exempt. (And remember… if you move, your protection may change dramatically.)
The 50 State Asset Protection Chart is a tremendous tool, compliments of The Wealth Preservation Institute (www.thewpi.org), the Asset Protection Society (www.assetprotectionsociety.org), and Duggan Bertsch (www.dugganbertsch.com). (But don’t stop there – verify independently that the information is up-to-date for your state!)
4. Protect Your Home (and other property) from Lawsuits and Judgments
Homestead Exemptions. Some states provide a lot of protection to home equity, which means that courts cannot award your home equity to creditors in the case of bankruptcy. In states such as Texas and Florida, state law protects an unlimited amount of home equity. Other states provide little protection to home equity in the event of bankruptcy.
Check the laws in your state. If your state provides a generous homestead exemption, the equity in your home may be a safe haven from creditors. (However, it is not liquid, so we caution clients against thinking of “equity” as an “asset.” You will also lose access to the equity and the cash if property values fall.)
Mortgages. Alternatively, if your state provides a minimal homestead exemption, it may make more sense to keep a large mortgage on your home, which discourages anyone from coming after your home. A free-and-clear asset is more vulnerable.
Titling. The way you have a property titled can have critical ramifications in the event of a lawsuit or judgment.
For instance, if you own your home with your spouse as tenants by the entirety, both you and your spouse own an indivisible interest in the home. If one of you is sued, creditors cannot force the other spouse to sell his or her interest in the house. This can help protect your home in a state where the law doesn’t provide a sufficient homestead exemption.(This option is only available in some states, and it applies only to your personal residence, not investment property.)
Tenancy by entirety can protect your home from personal or business creditors who win judgments against you, as a judgment cannot be placed against one spouse unless both are held jointly responsible. Other forms of titling include tenancy in common and joint tenants with rights of survivorship.Speak to a lawyer licensed in your state, well-versed in both real estate and asset protection, for specifics concerning your situation.
Gifting property. If you live in a state where community property laws apply, gifting property to your spouse (for instance, if you own a business that could make you a target and they do not) may make sense. In that case, a married couple is considered to own all property acquired during the marriage jointly, even if assets are titled in only one spouse’s name.
In other instances, gifting property to heirs while you are still living in it may be a workable strategy. Of course, provisions for you to retain use must be clarified in writing, and you must also carefully consider that heirs may be subject to lawsuits as well!
A gifting strategy can be used to protect and transfer other family assets as well. Creditors cannot seize assets that you no longer own. If you don’t expect to need the money while you’re alive, you might benefit from watching them enjoy the inheritance. Limited assets can be gifted to family members outright, without a trust. As of 2012, you can give away up to $13,000 per person without incurring a gift tax liability, subject to a lifetime exclusion of $5 million.
5. Protect Assets Long-Term with a Trust
Trusts can be used to control what happens to your assets when you are gone, but they can also be a way to protect assets from lawsuits and creditors while you are living. Irrevocable trusts allow you to remove assets from your estate. If assets are a part of your estate, creditors can obtain access to them with a judgment.
Irrevocable trusts can be created directly, or revocable trusts can be converted by default. A revocable trust will automatically revert to an irrevocable trust upon your death. At that point, the trust cannot be changed and the creditors of your estate cannot come after the assets that are in the trust, even when distributed to beneficiaries.
The process of setting up a trust that can stand up to creditors and lawsuits will require some professional help. We recommend consulting a good estate planning lawyer if you are considering setting up a trust.
6. Never Give Assets Away without a Fight!
A lot of people believe that if a you owe a creditor money or have a judgment against you, there is nothing you can do to fight it. This is not true! Companies must write off debts as losses after 6 months of non-payment, but then third party debt collectors often buy the debt for pennies on the dollar and pursue the debt, often pursuing judgments against consumers for inflated amounts.
Sadly, most consumers do not even fight these creditors, unaware that oftentimes the third-party creditors do not even have the proper paperwork to win a judgment, if challenged. Many will disappear if you simply ask them to validate the debt. Some are not even licensed to do debt collection in your state! Others may be legitimate, perhaps even working for the original creditor, but will likely negotiate solutions. However, it is much easier to negotiate a solution before a judgment than after a judgment has been won against you.
You may want to seek advice on negotiating debts to get you back on track financially. Consumer credit counselors may help lower your interest rate but are not typically negotiate balances. This article from Nolo.com may give you some more direction: “Negotiating on Credit Card Debt,” and NationalDebtRelief.com has tips on negotiating debt, plus they give assistance.
The Best Defense is a Good Offense
Sort of like insurance, asset protection strategies are best employed before there is a problem. Asset protection involves both financial and legal expertise, and if you have significant assets, you will want to consult a financial advisor licensed in your state, as well as an estate planning attorney.
Is it time to implement a strategy to protect your assets against lawsuits or creditors? Partners for Prosperity, Inc. practices in all 50 states, working with many accredited investors, business owners, and real estate investors. Read about our clients to see if we might sound like a match.