Why a financial plan should include asset protection

While individuals tend to focus on risk around markets, inflation, and other areas, they may overlook a serious risk to their net worth—creditor risk. As a result, they may not consider a plan to address this risk.

Asset protection is important to protect assets from a lawsuit, civil claims or bankruptcy, and is often associated with high-net-worth individuals, business owners or professions that are high-risk, such as medical providers. Still, people with comparatively modest financial assets, such as a home and retirement savings, also have reason to consider establishing an asset protection plan. Claims and lawsuits from car accidents, personal injury or liabilities involving family members can place assets at risk.

Covering the basics

Insurance forms the foundation for most asset protection plans. A first step in planning involves reviewing existing home and auto policies to make sure there is adequate liability coverage in case of some type of accident or event.

For auto policies, states regulate the minimum amount of liability coverage per person and per accident. For example, “25/50” coverage means that up to $25,000 per person is covered with a total of $50,000 for the entire accident. This is a prevalent minimum amount, but it is important to check with the state regulations to determine the specifics.

Homeowner policies are not regulated by states, but most homeowner policies provide a minimum of $100,000 worth of liability insurance, according to the Insurance Information Institute. Generally, adding additional liability coverage will not result in a significant increase in the premium.

Homestead protection can offer protection from certain creditors seeking to force the sale of a primary residence to meet a debt obligation. This protection does not shield a home from all debts. Debts that are not typically protected include mortgage liens, federal or state tax liens, liens for unpaid work, or debt involving a homeowner association. There are different types of homestead protection and filing requirements. State laws also vary.

Many states will also typically protect life insurance from creditors or in bankruptcy proceedings. The protection can be on the death benefit, the cash value or both. The levels of protection vary by state, so it is important to consult your state’s rules.

Consider umbrella insurance. Umbrella liability policies provide additional coverage beyond auto and home policies, starting at $1 million worth of coverage. At the same time, umbrella insurance requires policy holders to maintain a certain amount of liability coverage on auto and home policies, typically $250,000 on auto and $300,000 on home.

Retirement plans provide asset-protection

Retirement plans can be an option for protecting assets from creditors. Title 1 of ERISA provides full protection of qualified retirement plans from creditors. ERISA-qualified plans may include pensions, profit-sharing plans, and employer sponsored 401(k) plans. For the last twenty years federal law has also provided protection to IRAs for those undergoing federal bankruptcy proceedings. However, outside of the bankruptcy process IRA savings may be subject to attachment from creditors.

Many states, but not all, extend additional protection to IRAs. It is important to consult with a legal professional about statutes in a particular state. For example, if a state does not fully protect IRA savings it may be wise to leave funds within an ERISA-qualified retirement plan like a 401(k) if creditor risk is significant.

Advanced strategies

Several advanced strategies may be used as part of an asset protection plan including certain trusts or establishing separate LLCs to own assets, such as rental real estate.

Trusts allow an individual to transfer ownership of assets held to a trustee to hold for the benefit of a designated beneficiary. To provide protection from creditors, trusts should be irrevocable and include a spendthrift provision which restricts a beneficiary's access to trust assets. In that case a trustee generally cannot be compelled to distribute funds from a trust to satisfy the creditor claims of a trust beneficiary. Additionally, foreign trusts, which are governed by a foreign jurisdiction, and Domestic Asset Protection trusts, available in some states, may be part of a plan but require thorough analysis from a legal professional specializing in this area of the law.

Business owners may want to structure ownership to protect assets. To protect from claims against the business, consider incorporating the business and creating a C corporation or S corporation for federal tax purposes. Additional strategies include limited liability companies (LLCs) and limited partnerships (LPs), which are considered separate legal entities and not deemed owned by the individual. In particular, rental real estate  can carry significant risk that should be addressed and managed. Having a separate legal entity, such as an LLC, can be a effective option.

Expert advice

Asset protection is an important consideration for any comprehensive financial plan. Individuals may want to review their current insurance coverage with a financial professional and discuss establishing an asset protection plan. Consultation with insurance and legal professionals may also be needed. When pursuing advanced strategies, it is particularly important for individuals to meet with a qualified legal  professional for tailored advice and expertise on any state-specific laws.

To learn more about asset protection strategies, see our piece on “Asset Protection: Basic principles and strategies for safeguarding your wealth.”