You’ve worked hard all your life to accumulate a little personal wealth. One frivolous lawsuit could wipe it all out.
In today’s litigious society, many people need to take steps to protect their assets from lawsuits and illegitimate creditor claims.
“Many people are good at playing offense, meaning earning the money or saving, but all too often, they forget to play defense,” said Michael Busch, a certified financial planner and president of Vogel Financial Advisors in Dallas.
You don’t have to be superrich to take some action.
Some steps you can take include making sure that you have enough liability coverage on your homeowners’ and auto insurance policies, and purchasing an umbrella policy that provides additional coverage above the limits on your primary policies.
Do it now
Don’t wait until trouble is at your door to take action. At that point, trying to protect assets from a claim probably would do more harm than good.
“It is imperative that asset protection strategies be implemented before there is a problem,” Busch said. “Once a creditor has a claim or is likely to have a claim, any subsequent transfer may be deemed fraudulent. If a court believes a transfer was made with the intent to defraud legitimate creditors, the transfer will not be upheld.”
Protecting your personal assets from litigation can get very complicated, and if you have a lot to protect, you should hire a lawyer and financial adviser.
But first, you need to be sure that you have enough assets to make the effort worthwhile.
“Most people, if they don’t have a sizable portfolio or net worth to protect, it’s not feasible to take the extra steps to protect it,” Busch said. “Generally, someone’s not going to bother filing a lawsuit against someone who they know has few assets.”
But let’s start with the basics.
If you own a home, homeowners’ insurance protects you against financial loss if you’re found responsible for someone’s injury or property damage.
Your auto insurance does the same thing as it relates to your automobiles. Liability insurance pays for bodily injury, property damage and some additional expenses of other drivers, their passengers and your passengers when you or a driver covered by your policy causes an accident. Liability insurance doesn’t pay for damage to your own vehicle.
Umbrella policies
If you want more liability coverage than your primary insurance policies provide, you can buy a separate personal umbrella policy.
Umbrella coverage applies only to losses over a large dollar amount, but terms of coverage are sometimes broader than those of underlying policies.
Because umbrella policies vary, make sure the insurance agent or company fully explains the coverage.
What’s safe from creditors
You also have some built-in protection under the law. Wages may be garnished only to pay child support, back taxes and defaulted student loans.
Retirement plans, such as individual retirement accounts, 401(k)s, 403(b)s, profit-sharing plans and pensions can’t be seized by creditors. They also can’t seize the cash value of a life insurance policy or death benefits from the policy.
Busch said if you’re worried about future litigation, you can use part of your money to pay down your mortgage. That transfers your money into the protected asset – your home.
“If you had that same money in a bank account, a lawsuit could get to it, but if it’s in your house, it’s protected,” he said. “You’re taking exposed assets and converting them into assets that are creditor-protected.”
For more complicated financial situations, you need to consult an attorney. That’s especially true if you’re already in financial trouble.
“If you’re already in financial trouble, there is no surefire method to protect your assets from rightful creditor claims,” said Bill Wallander, a partner at Vinson & Elkins LLP in Dallas. “Once you’re in that situation, it’s a matter of whether you can restructure things with your creditors through negotiations, and if you can’t restructure your financial challenges with your creditors, then the individual needs to consider whether bankruptcy is an appropriate solution.”
Keep in mind that the new bankruptcy law, which takes effect in October, will make it harder to file for bankruptcy.
“If you know that you’re already insolvent or if you’ve already been sued and you start to take steps to protect your assets – transfer your assets into a trust or family partnership or try to convert your assets into exempt property – that may raise questions as to what your intent was,” Wallander said.
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Beyond homeowners’ and auto insurance, here are three general scenarios of consumers and what they can do to protect themselves.
If you’re an apartment dweller, consider renters’ insurance.
“Most apartment complexes are virtually requiring people to carry renters’ insurance,” said Jerry Johns, president of Southwestern Insurance Information Service in Austin, Texas, which represents property-casualty insurance companies.
There are several benefits to renters’ insurance.
First, a landlord’s insurance doesn’t cover a renter’s personal property.
Renters’ insurance covers your belongings and pays extra living expenses if a fire or other disaster forces you to move temporarily from your rented home.
It also provides liability protection. If someone slips and falls in your apartment and sustains a serious injury, he or she could sue you for financial damages.
Renters’ insurance policies vary, so be sure to ask the insurance company about liability limits.
A young apartment dweller who hasn’t built up much in the way of assets probably doesn’t need an umbrella policy.
For a small-business owner, “The structure of the entity is going to be key,” said Michael Wald, an estate planning lawyer at Wald & Associates in Richardson, Texas.
What you want to do is to separate your personal assets from the assets of your business.
That can be accomplished by how you set up your company under the law.
“They ought to think about making sure they incorporate their business and put in an entity that’s creditor-protected like a C corporation and an S corporation,” Busch said.
In those two corporate structures, shareholders have limited liability and can only lose what they’ve invested in the business.
“Personal assets aren’t subject to liability,” Wald said.
That contrasts with a sole proprietorship structure, which leaves you wide open because the owner has unlimited personal liability for all the business’ debts.
“You’re indistinguishable from your business, so they can go after your personal assets and business assets,” Busch said.
Someone in the latter situation would be well advised to keep their umbrella liability policy up to date.
A controversial tool is the family limited partnership, or FLP, which offers extra asset protection to wealthy families. The FLP is a separate legal entity that requires its own tax return.
“In the typical scenario, family savings, investments and titles to business and real estate interests are transferred into the FLP, which if properly structured, protects those assets from potential claims and lawsuits,” said California attorney Robert J. Mintz.
But the Internal Revenue Service has challenged FLPs, saying they’re tax-avoidance tools, and it recently won a series of victories.
The most recent involved a family limited partnership of Albert Strangi, the late Waco, Texas, millionaire.
The U.S. Court of Appeals for the 5th Circuit affirmed an earlier tax court ruling that found that assets transferred into the partnership should be included in Strangi’s estate and thereby are subject to estate taxes.
Wald said family limited partnerships are still a valid asset-protection tool, but they must be more carefully constructed.
“You should go to great lengths to make sure that you form it (properly) and that you operate it as an FLP. You certainly can’t treat it as your own bank account.”
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AP-NY-09-12-05 0622EDT
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