Don't Let Creditors Crack Your Nest Egg

As an estate planning attorney, it is my job to provide legal solutions allowing you to plan for tomorrow so you can enjoy life today. With a large federal estate tax exemption ($11.4 million per person in 2019), many clients are shifting their attention to strategies that achieve income tax and creditor protection benefits. All clients, especially high-net-worth clients with increased risks (stressful careers, multiple properties, etc.), should work with their estate planner and financial advisor to achieve a desired level of protection. The purpose of this blog is to introduce creditor protection techniques so you are prepared for a personalized conversation with your advisors.

The first step in any creditor protection analysis starts with identifying potential creditors. Patients, clients, and customers are creditors connected to your career. Third parties and guests may be hurt when driving or while visiting your home (or rental home). Protection in the event of a divorce should also be considered. It is important to note that the mix of potential creditors changes as your life and career progress.

Step two is designing a plan that is right for the risks you face and your risk tolerance (at your current life stage). BrownWinick often considers creditor protection strategies as a continuum. We start by reviewing and implementing simple and cost-effective strategies before adding more complex techniques. I generally view the creditor protection continuum as follows:

  1. Be purposeful when titling assets. Asset titling is extremely important. By titling assets purposefully, you can often provide the asset’s benefits to multiple parties without conveying legal ownership. Married couples often create joint accounts for simplicity, ease of use, and to view the assets as “ours.” If you are sued or divorced, this co-ownership will likely create liability for your one-half ownership. Rather than adding a spouse as a co-owner, consider adding signature rights to the account so the spouse with higher risk can access the account without having legal ownership (and associated liability to creditors). Bullets #5 and #6 also touch on asset titling.
    1. Younger clients should resist the urge to title all assets to the spouse with the less risky profession. This increases risk in divorce. And remember, the “non-risky” spouse is just as likely to be involved in a bad business deal or car/home accident.
  2. Review insurance coverage. Developing a good relationship with your insurance agent is key to protecting yourself against life’s known but unpredictable risks. Many clients ensure that they have sufficient malpractice insurance but overlook adequate coverage for risks created by driving, owning a home(s), and everyday risks (umbrella policies). Because insurance policies protect against specific risks, make sure your agent knows how each asset is titled and used (i.e. residence versus rental property), and how your policies work together. Importantly, review and update your coverage periodically as assets and circumstances change.
  3. Fund retirement accounts and other exempt assets. Iowa, like many states, exempts certain assets from the claims of creditors. You should fully fund your retirement accounts on an annual basis (Roth or traditional) and pay down debt on your personal residence, as both offer financial rewards and are currently exempt from creditors.
  4. Consider premarital agreements. If contemplating marriage, drafting a premarital agreement can reduce risk in the event of divorce. Premarital agreements are becoming more common and their negative stigma continues to dissipate. Iowa law does not currently allow agreements created after a couple has been married, though other states do allow such post-marital agreements. 
  5. Create entities to achieve limited liability. Holding assets in limited liability entities (professional corporations, LLCs, LLPs) allows creditors to make claims against certain entities but protects personal assets not held in the entity creating the liability. You should group assets based on risk type and the identity of owners.
  6. Basic trust planning. Revocable trusts (“living trusts”) generally don’t provide creditor protection during your life, but they can create protection for beneficiaries after your death. I generally recommend the use of marital trusts for high-net-worth clients. The marital trust is created at the first spouse’s death and provides access to assets during the surviving spouse’s life. At the surviving spouse’s death, assets are passed to your chosen beneficiaries (usually to a Family Trust). Income tax efficiency should be weighed against access to assets in the event of the surviving spouse’s remarriage. Also, purely discretionary trusts (rather than the use of the common “health, education, maintenance, and support” standards) may result in increased creditor protection for your beneficiaries.
  7. Use life insurance to create a nest egg. Clients in their 30s and 40s who have sufficient cash flow should consider life insurance to achieve creditor protection and a “nest egg” for beneficiaries (generally, kids and grandchildren). Forming an irrevocable life insurance trust (ILIT) can accomplish multiple estate planning goals.
  8. Advanced trust planning. A number of advanced trusts (usually irrevocable trusts with fancy acronyms) can accomplish different estate planning goals. BDITs, SLATs, and DAPTs are attractive (but more costly) trusts for clients who wish to be more aggressive with creditor protection. A brief overview of each are:
    1. BDIT. Beneficiary Defective Irrevocable Trusts. A third party (usually a parent) creates a trust for the benefit of you, the client. You are deemed the owner of the trust for income tax purposes but not for legal purposes (achieving creditor protection). The BDIT requires you to sell assets to the BDIT for fair market value.
    2. SLAT. Spousal Lifetime Access Trust. An irrevocable trust created to provide lifetime benefit for your spouse. Risk of divorce complicates this technique for younger clients.
    3. DAPT.  Domestic Asset Protection Trust. A revocable trust created in a favorable trust jurisdiction that attempts to achieve the flexibility of a revocable trust with the protection of an irrevocable trust. These trusts are fairly new, not universally accepted, and have limited case law.  

Life is full of risks, but that shouldn’t stop you from enjoying your career and time with loved ones. Working with your attorney and other advisors to implement basic asset protection strategies and adding more advanced techniques as you age (or risks change) will help prepare for life’s uncertainties so you can sleep soundly at night.