How to Protect Your Assets From a Lawsuit or Creditors

If you don't properly protect your assets, they can potentially be lost in a lawsuit, bankruptcy, or to other creditor actions. It's important to understand the laws that can provide asset protection and to know what measures you can take to protect your savings.

Why You Need Asset Protection

Having asset protection is critical to protecting your assets from creditors. There are many circumstances in which your assets can be attached or garnished by creditors, including if you file for bankruptcy, get a divorce, or are in a civil lawsuit.

It's important to consider these circumstances before they occur, If you don't protect your assets properly, you could lose them.

Asset Protection Caps for IRAs

Contributions and earnings in your traditional or Roth individual retirement accounts (IRAs) have an inflation-adjusted protection cap of $1 million against bankruptcy proceedings.

In addition, amounts rolled over from qualified plans, such as 403(b) and 457 plans, have unlimited protection. However, this protection only applies to bankruptcy, not to judgments awarded in other courts like if someone was injured due to your actions. Protection also does not include judgments for most domestic relations lawsuits, such as child support. In such cases, state law must be consulted to determine whether any protection exists and to what degree.

Qualified Retirement Plans

Assets in employer-sponsored plans have unlimited protection from bankruptcy, regardless of whether or not the plan is subject to the Employee Retirement Income Security Act (ERISA). This includes SEP IRAs, SIMPLE IRAs, defined-benefit and defined-contribution plans, 403(b) and 457 plans, and governmental or church plans under the Internal Revenue Service (IRS) code section 414. Amounts in your SEP IRA from regular IRA contributions are currently subject to a $1,512,350 limitation. This amount is adjusted for inflation every three years.

ERISA plans are also protected in all other cases, except under qualified domestic relations orders (QDRO)—where assets can be awarded to your former spouse or other alternate payees—and tax levies from the IRS. For this purpose, a qualified plan is not considered an ERISA plan if it covers only the business owner. The protection for owner-only plans is determined by state law.

Homesteads

Homestead exemption is a legal exemption in many states that protects a home from creditors following the death of a spouse or during bankruptcy.

The amount of protection you have for your home varies widely from state to state. Some states offer unlimited protection, others offer limited protection, and a few states provide no protection at all.

Annuities and Life Insurance

Asset protection for annuities and life insurance is determined by state law. Some protect the cash surrender values of life insurance policies and the proceeds of annuity contracts from attachment, garnishment, or legal process in favor of creditors.

Other states protect only the beneficiary's interest to the extent reasonably necessary for support. There are also states that do not provide any protection. 

How to Plan for Asset Protection

You can plan for asset protection in several ways. The key is to create as many obstacles as possible for creditors before they can legally claim rights to your property. Here are several ways to protect your assets.

Asset Protection Trusts

Several states, including Alaska, Delaware, Hawaii, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming, allow asset protection trusts (APT), which are a type of irrevocable trust.

Asset protection trusts offer a way to transfer a portion of your assets into a trust run by an independent trustee. The trust's assets will be out of the reach of most creditors, and you can receive occasional distributions. These trusts may even allow you to shield the assets for your children.

The requirements for an asset protection trust are:

• It must be irrevocable.
• The trustee must be an individual located in the state, or a bank or trust company licensed in that state.
• It must only allow distributions at the trustee's discretion.
• It must have a spendthrift clause.
• Some or all of the trust's assets must be located in the trust's state.
• The trust's documents and administration must be in the state.

If you are considering an asset protection trust, consider working with an attorney who is experienced in this field. This way, you can ensure your trust meets regulatory requirements.

Accounts-Receivable Financing

If you own a business, you could borrow against its receivables and put the money into a non-business account. This would make the debt-encumbered asset less attractive to your creditors and make otherwise accessible assets untouchable.

Stripped-Out Equity

Another option for protecting your assets is to pull the equity out of them and put that cash into assets that your state protects. Suppose, for example, that you own an apartment building and are concerned about potential lawsuits. If you took out a loan against the building's equity, you could place the funds in a protected asset, such as an annuity (if annuities are sheltered from judgments in your state).

Family Limited Partnerships

Assets transferred into a family limited partnership (FLP) are exchanged for shares in the partnership.

Because the FLP owns the assets, the assets are protected from creditors under the Uniform Partnership Act (UPA). However, you control the FLP and thus the assets. There is no market for the shares you receive, so their value is significantly less than the value of the asset exchanged.

Other Asset Protection Strategies

Here are some other inexpensive, simple ways to protect your assets:

• Transfer assets to your spouse's name. However, transferring assets to your spouse could have consequences if you divorce.
• Put more money into your employer-sponsored retirement plan because it might have unlimited protection.
• Buy an umbrella insurance policy that protects you from personal injury claims above the standard coverage offered by your home and auto policies.
• Make the most of your state's laws regarding homesteads, annuities, and life insurance. Paying down your mortgage, for example, could protect cash.
• Don't mix business assets with personal assets. That way, if your company runs into a problem, your personal assets may not be at risk.

The Bottom Line

If you are considering hiring an asset protection service, check with the Better Business Bureau (BBB) before deciding to use any of these services. Additionally, consider consulting with an attorney who is familiar with the laws of your state and who is an expert in asset protection.