Asset Protection Strategies

There are many tools that will help you protect the assets that you have worked so hard to earn. They include protecting them during your life from creditors and predators. They include protecting them after your life from creditors, predators and even your beneficiaries themselves.

Insurance is your first line of protection for events that can strip you from your assets: automobile insurance, homeowner's insurance, medical insurance, disability insurance, long term care insurance, malpractice insurance, and the list goes on. There is insurance for most risks.

Americans hold nearly $15 Trillion in IRAs and qualified retirement plans. More than 41% of all U.S. households have at least one IRA. Qualified retirement plan accounts are asset protected under federal law, and IRAs are protected to at least some extent under state law. ERISA (the federal Employee Retirement Income Security Act of 1974) provides protection from creditors for all qualified plan assets while they remain inside the plan. ERISA's asset protection for qualified plan distributions, however, depends upon whether the plan is a pension plan (complete protection) or a welfare benefit plan (no protection). Under ERISA, a "pension" plan is any "plan, fund or program which...provides retirement income to employees." Defined benefit pension, profit sharing, and 401(k) plans are all "Pension" plans under that definition. ERISAs protections are the same in bankruptcy court and outside of bankruptcy. However, many wrongly believe that these accounts automatically will remain asset protected after their owners die. Planning is the best preparation! Inherited IRAs are no longer protected under federal bankruptcy law. Only 8 states in 2014 protected them by state law. That is one reason why seeking protection through an irrevocable trust may be wise.

Premature plan owner deaths and minimum required distribution rules are designed to never force retirees to exhaust their IRAs and qualified plans. The result is that those two factors transfer a significant portion of assets to the owners' beneficiaries. Those are determined by each account's beneficiary designation. That designation determines who is the beneficiary and whether the money is given outright to a beneficiary or held in trust for a beneficiary's benefit. Inherited IRAs are no longer

In addition, tax impacts should be considered. Unlike most other assets that receive a "basis step-up" to current fair market value upon the owner's death, IRAs, 401(k)s and other qualified retirement plans do not step-up to the date-of-death value. Therefore, these assets will be subject to income tax. If the estate also is subject to estate tax, the value of these assets may be further reduced by federal estate tax. And if your clients name grandchildren or younger generations as beneficiaries, these assets may additionally be reduced by the generation skipping transfer tax at the highest federal estate tax rate. All told, these assets may be subject to 70% tax or more. If the money is paid outright, the tax is outright too. The net distribution to the beneficiary will be reduced accordingly.

In addition to tax, naming a beneficiary outright to accomplish tax deferral with a tax-qualified plan has other disadvantages. First, if the beneficiary is very young, the distributions must be paid to a guardian; if the beneficiary has no guardian, a court must appoint one. Another disadvantage is the potential loss of creditor protection or bloodline protection particularly where the named beneficiary is the surviving spouse. A third, practical disadvantage is that many beneficiaries take distributions much larger than the required minimum distributions. In fact, studies show that beneficiaries consistently consume "found money" in only a couple of years regardless of the amount in the account or the age of the beneficiary. Talking about family dynamics with your attorney allows a personalized plan to be created to address your needs.

A revocable trust provides no asset protection for the trust making during his or her life.

Trusts for the lifetime of the beneficiaries provide prolonged asset protection for the trust assets. Lifetime trusts also permit your financial advisor to continue to invest the trusts assets as you instruct, which can help ensure that trust returns are sufficient to meet your planning objectives. The second caveat follows logically from the first; the more rights the beneficiary has with respect to compelling trust distributions, the less asset protection the trust provides. Generally, a creditor 'steps into the shoes' of the debtor and can exercise any rights of the debtor. Thus, if the beneficiary has the right to compel a distribution from a trust, so too can a creditor compel a distribution from that trust.

By naming a trust as the beneficiary of tax-qualified plans, your can ensure that the beneficiary defers the income and that these assets remain protected from creditors or a former son- or daughter-in-law. A stand-alone retirement trust (separate from a revocable living trust and other trusts) can further help ensure that it accomplishes your objectives while also ensuring the maximum tax deferral permitted under the law. This trust can either pay out the required minimum distribution to the beneficiary or it can accumulate these distributions and pay out trust assets pursuant to the standards you set in advance (e.g., for higher education, to start a business, etc.).

Another relatively simple option is for you to name a charity as a designated beneficiary at their death or at the death of their survivor, if married. This strategy is particularly attractive for those who intend to make gifts to charity at death and the question is simply what assets should they select. As a tax exempt entity, a qualified charity does not pay income tax and therefore receives the full value of tax-qualified plans. In other words, if the beneficiary is in a 35% tax bracket, a $100,000 IRA is worth only $65,000 in his or her hands, but is worth the full $100,000 if given to charity. Therefore, it makes economic sense to give these assets to charity and give to their beneficiaries assets that are not subject to income tax after death.

Structuring tax-qualified plans to provide the longest term payout possible is the most common option to allow the maximum tax-deferred growth. With this strategy, you name beneficiaries in a way that requires the beneficiaries to withdraw the least amount possible as required minimum distributions (those distributions that the beneficiaries must take in order to avoid a 50% penalty). Frequently, married clients name the surviving spouse as the primary beneficiary so that the survivor may roll over the account into his or her name and treat the account as his or her own. The surviving spouse then names younger beneficiaries for stretch-out purposes. To achieve the maximum "stretch-out," you should name beneficiaries who are young (e.g., children or grandchildren, although there are special considerations when naming grandchildren or younger generations). The younger the beneficiary, the smaller the required minimum distributions. To achieve maximum income tax deferral, beneficiaries should take only their required minimum distributions.

Alternatively, if you are concerned about the loss of creditor or divorce protection that occurs when they name beneficiaries outright, you can name a beneficiary's share of a trust as the designated beneficiary of their tax-qualified plans.