Asset Protection Trusts – How Do They Work?

One of the boxes frequently checked as “very important” on financial planning questionnaires is Asset Protection. Let’s face it; we live in a litigious society. Wouldn’t it be nice if you could just start singing the MC Hammer song “Can’t Touch This” if someone sued you and demanded all of your assets? Sadly, for MC Hammer, even good asset protection cannot protect you from bad spending decisions. He was bankrupt two years after earning $30 million, but I digress.

Want to make yourself more bulletproof from unscrupulous creditors?

Let’s look at a couple of things you could do to make yourself more bulletproof from unscrupulous creditors. Most people like the idea of putting their money in a living trust that would protect their assets. This is possible with one major caveat … if you have direct control of the trust (as is the case with commonly used revocable living trusts), then it is not out of the reach of your creditors. An Asset Protection Trust (APT) requires that the trustee (person who controls the assets and distributions) be someone other than you or your immediate family members. That is a deal killer for most people, but not all.

An Asset Protection Trust may be an appropriate solution for people in high-risk professions such as doctors, attorneys, architects, engineers, developers, and other small business owners. Asset protection is subject to state law, and some states are more favorable than others. Nevada is generally regarded as having the best creditor protection statutes. People from all over the country may use a Nevada Asset Protection Trust but typically at least one trustee must reside in NV. The look-back period is only two years in Nevada, compared to four for most other states. The look-back period is the time between when you transfer assets into the trust and the time the assets become protected. So plan at least a couple of years in advance of any lawsuits.

Are asset protection trusts too much cost and hassle to set up?

Asset Protection Trusts are not commonly used by the vast majority of the population because of the costs and hassles involved. However, there are some easier ways to protect a significant portion, if not all of your assets. We call these the “low hanging fruit” of asset protection strategies:

  1. The entire balance of qualified retirement plans (e.g., 401k, 403b, pension) are protected from creditors automatically.
  2. IRA accounts are protected from creditors up to $1.245 million in 2016 and indexed for inflation. This does not include inherited IRA’s, which are not protected.
  3. Rollover IRAs (balance was transferred in from your qualified retirement plan are also protected and the protected balance is unlimited).
  4. Home equity up to the homestead exemption in your state.
  5. Many states exempt cash value and policy proceeds of life insurance and annuities.
  6. 529 Plan balances (college savings) may enjoy some protection (also varies by state).
  7. Umbrella liability insurance is an inexpensive and simple way to protect your assets from judgments above the limits contained in your auto and homeowner policies.
  8. Holding assets in an Limited LKiability Company (LLC), e.g., rental real estate, makes those assets unattractive to creditors.

Naturally, asset protection is a specialized area of law, so I would recommend checking with your favorite estate planning attorney for the specifics in your state. Let me know if you need the contact info for a good attorney in your area.

P.S. I hope you never get sued and all of this info will be irrelevant.