Many people are concerned about protecting their assets from potential creditors. But when people hear “asset protection,” they usually think about complicated trust structures. There are many different ways to protect your assets in advance of a creditor’s claim, ranging from simple to very complex. Oftentimes, the simpler solution will give you the protection that you need.

Umbrella Coverage

Umbrella coverage is excess personal liability coverage – it protects you from major claims and lawsuits, thus helping to protect your assets.

There are two aspects to umbrella coverage. First, it can provide additional liability coverage above the limits of your property and casualty insurance policies (e.g., boat or automobile insurance). This coverage is designed to kick in when the liability coverage on those other policies has been exhausted. Second, it provides coverage for claims that might be excluded by other liability policies, such as false arrest, defamation (libel and slander), liability on rental units you might own, etc. As well as covering losses from these risks, umbrella coverage also helps cover attorneys’ fees and, in some cases, other charges associated with lawsuits.

In addition to umbrella coverage, you can also consider specialized insurance, such as kidnap and ransom insurance or identity fraud protection, as well as directors and officers liability insurance (if you serve on any boards of directors) and employment practices liability insurance (which, if you are an employer, protects you against employment-related claims, including discrimination and wrongful termination).

Asset titling – Titling assets in a spouse’s name, or tenancy by the entirety

One easy way to avoid having your assets subject to creditors’ claims is not to have any assets in your own name. If you are married and are concerned about your creditors (i.e., if you are in a profession, such as a doctor, where you can have personal liability beyond professional insurance limits), putting assets in your spouse’s name removes those assets from your creditors’ reach. However, since such assets will now be subject to your spouse’s complete control, they will be in the reach of your spouse’s creditors. In addition, if there is any concern that you and your spouse may divorce, you may not want to put assets into your spouse’s name.

An alternative for married couples is titling assets as tenancy by the entirety. Tenancy by the entirety is a special type of joint tenancy with rights of survivorship for spouses – it provides protection from the creditors of either spouse, although this varies state-by-state based both on state law and the kind of property (real property, personal property, etc.). (In any state, a joint creditor could potentially make a claim on your joint property, though, and Federal creditors can generally attach entirety property at any time.)

Homestead

Some states allow you to declare a “homestead,” allowing the value of your home to be favored in a number of ways, including by being protected from the claims of your creditors. The strength and amount of the homestead exemption varies by state; you should check to see whether your state allows a homestead and up to what value.

Retirement accounts and IRAs

Employer-sponsored qualified retirement plans governed by ERISA (the Employee Retirement Income Security Act of 1974) are federally protected from the claims of creditors. IRAs, on the other hand, are governed by state law, and the extent of their protection varies by state; once an IRA owner dies, a non-spousal inherited IRA often will have less protection than the IRA did during the owner’s lifetime. In any case, acquiring assets in retirement accounts – including ones you set up yourself for your own business – is another way to protect assets relatively simply.

Limited liability entities (LLCs, limited partnerships, S corporations)

Creating an entity is another – albeit more complicated – way to protect your assets from creditors’ claims. The more the entity acts at arms length from you, the harder it will be for your creditors to reach the entity’s assets – although, absent additional planning, your creditors are likely to be able to attach your interest in the entity and therefore any distributions made to you from the entity.

What does it take to be “arms length”? Unfortunately, there is no bright line rule; but, the more you respect the entity as being separate from your personal assets, the more likely the entity’s assets will be protected from your creditors. Among other things, this means that you shouldn’t give all of your assets to one or more entities – if you render yourself insolvent as a result of transfers of your assets to entities, it is unlikely that a court will respect the transfer. In addition, the entity should have more participants than just you.

To make sure your entity is respected at the state level, it should have a clear business purpose, and you should make sure that you separately differentiate the activities of the entity from your personal activities – keep separate books and records, receipts, etc.

Irrevocable gifts (Including gifts to trusts)

Gifts you make to others – often to children or to trusts for their benefit – will generally be outside of the reach of your creditors so long as no claim is anticipated by the donor at the time of the gift. In order for the gifted assets to be out of your creditors’ reach, the gift (and trust) must be irrevocable; as a result, you should only make irrevocable gifts if you are confident that you won’t need the gifted assets to fulfill your other lifetime goals. (There are also potential transfer tax benefits; please see WealthFocus on Fundamental Estate Planning Considerations.)

Importantly, gifts in trust for your children can be structured to protect the assets in the trust from not only your creditors but also your children’s creditors. Since a creditor can include a child’s potential ex-spouse, gifting to your children in trust can be a powerful way to benefit your children while protecting the assets you put in trust from unwanted spousal (or other creditor) claims.

Asset protection trusts

Some states, and certain foreign jurisdictions, have laws in place that allow you to create an irrevocable trust for your own benefit (and the benefit of others). These structures are complex and generally require the services of an institutional trustee. The benefit of this strategy is that your assets can be placed beyond your creditors’ reach but within your reach under certain circumstances – generally, assuming the trust is structured properly, after the expiration of the statute of limitations for transfers. The shorter the statute of limitations, the quicker the assets are likely to be protected from creditors’ claims.

As with the creation of an entity, you are not likely to get the benefit of asset protection if you render yourself insolvent by transferring too much to an asset protection trust and withdrawing assets regularly from it to cover your personal expenses. Asset protection trusts are complex instruments, and you should consult a lawyer and tax advisor as you consider creating one.

Combining techniques (Entity + asset protection trust)

Sometimes less is more, but for asset protection, sometimes more is more. If you create an entity, transfer assets to the entity, and then contribute the entity to an asset protection trust, you can give yourself two layers of protection – even if a creditor can somehow “break through” the asset protection trust, your assets are still protected in an entity. It will require that much more effort on the part of your creditors to reach the assets inside the entity – and the reasons a court might disregard an asset protection trust are different from the reasons a court might disregard an entity.

As always, you should consider the tradeoff between complexity on the one hand, and effectiveness on the other. Often, you can achieve significant asset protection with relatively simple techniques. But, you may be willing to assume the added complexity of the more sophisticated techniques for the additional creditor protection benefits these techniques offer.

Talk to a J.P. Morgan advisor to review your options if you have concerns about your or your children’s creditors, and always engage independent legal counsel before undertaking any sophisticated planning.