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Randall D. Armour: Does estate planning offer creditor protection?

It’s Your Money

Posted: February 10, 2010 10:06 p.m.
Updated: February 11, 2010 4:55 a.m.
 
One of the most common questions I am asked when meeting with a client to discuss estate planning is whether or not the estate plan will offer them protection from creditors.

In today’s litigious society, many people who invest in real estate or are involved in high-risk businesses are constantly worried about potential liability to a tenant, customer, passerby or anyone else who may sue in an attempt to make a buck.

Basic estate planning usually involves planning for the management of assets upon incapacity, and distribution of assets upon death with the least amount of cost and inconvenience.

In most cases, these objectives are met by using a revocable living trust. A revocable living trust, however, provides no protection from creditors for the people who establish the trust and place their assets into the trust (self-settled trusts).

Because asset protection has become such an important issue in many people’s minds, I will discuss different methods that can and have been used to protect assets from creditors.

This is certainly not an exhaustive list of asset protection techniques and I am not an expert in this area of law. If you want asset protection you must consult an expert to determine the proper method, if any, given your specific circumstances.

Marital property
The manner in which a married couple holds title to property can determine a creditor’s ability to seize marital assets. In general, the community property can be attached for debts incurred by either spouse, while the separate property of one spouse can only be reached by the creditors of the spouse who owns the separate property.

However, significant tax and estate-planning advantages may be lost by characterizing property as the separate property of one spouse.

Forming an entity
Forming a corporation, LLC or limited partnership is often the best method for people who own a business or investment property that they want to segregate from other assets for liability purposes. The best type of entity will vary depending on the type of assets owned and tax considerations.

Being properly insured
Many people feel that the easiest and most cost-effective approach to asset protection is to insure themselves against liability. For example, if you have a $2 million umbrella policy and someone slips and falls at a property you own and is awarded a $1 million judgment, your insurance policy will cover the judgment and you won’t lose any property.

The problem is that you can never know for sure how much insurance is enough to cover any potential claims.

Asset protection trusts
There are many types of asset-protection trusts that are commonly marketed. Most jurisdictions including California have a prohibition against someone establishing a trust to protect their own assets (“self-settled” trusts).

Many foreign jurisdictions and some states have adopted special laws to allow self-settled asset-protection trusts, but the United States will generally not recognize these foreign laws and the laws of other states will generally not be effective for California residents.

In my opinion, these trusts are often over-hyped, overpriced and ineffective.

In recent years, the IRS has aggressively sought to impose severe civil and criminal penalties for tax evasion for both promoters and participants in offshore trusts.

Many asset-protection plans involve a combination of various devices. It is also important to keep in mind that there are laws in place to protect creditors against fraudulent transfers of assets with actual intent to hinder, delay or defraud a creditor.

These fraudulent transfer laws must always be taken into account when any asset-protection plan is devised and implemented.

Randall D. Armour is an attorney and licensed real estate broker. “It’s Your Money” appears Thursdays and rotates between a handful of the valley’s financial professionals. His column reflects his own views and not necessarily those of The Signal.

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