What Is Asset Protection?

Asset protection is a catchall term referring to the various legal strategies that you can take to protect your wealth (i.e. your assets) from creditors. It is a critical element of any financial plan.

Perhaps you’ve given asset protection a lot of thought, particularly if you work in a profession where the risk of losing your assets is high. Or perhaps you haven’t given the matter quite as much thought.

Whatever your situation, it is crucial that you plan ahead, because once you have a need to protect your assets, it is usually too late to legally protect your assets.

This is the central paradox of asset planning, and it can be traced back to the Uniform Fraudulent Transfer Act (UFTA).

The Uniform Fraudulent Transfer Act

 

The UFTA is a law that governs asset transfers in California. Most other states have adopted similar laws, and the roots of the UFTA go back to sixteenth century English common law. Essentially, the UFTA forbids debtors from making transfers of property to third parties in order to avoid paying debts.

For instance, let’s say that you are about to go into debt. There are a variety of reasons why you might find yourself in this situation: you may have been sued, you may have taken out a loan that you are unable to repay, you may have gone into bankruptcy, or you may have been audited by the IRS or another government authority.

But whatever the reason, let’s say that once you find yourself in this situation, instead of paying your debts, you give most of your assets to a trusted friend or relative so that the debt collectors cannot get ahold of them. You do this with the intention to reclaim those assets later, once the coast is clear.

If you do this, you will be guilty of a fraudulent transfer. It’s easy to see why: if everybody transferred their assets when they were in debt, then nobody would ever be able to recover any debts.

What exactly makes a transfer fraudulent? This is a complicated question, and there are a variety of badges of fraud that investigators look for in making this determination, including the amount of assets that you transferred and whether or not you found yourself insolvent (i.e. unable to pay your debts) after the transfer was completed.

However, one of the most important badges of fraud that investigators search for is timing. If you make a transfer after a debt is incurred, then that transfer is much more likely to be found fraudulent than if you made it long before the debt was incurred.

Hence the central paradox of asset protection: once you have a need to protect your assets, it is usually too late to legally protect your assets.

This is a basic truism of asset protection, and is why you need to take steps to protect your assets right now. If debt seems like a remote possibility, then that means that it is the time to consider asset protection. Procrastination is never good, but this is doubly true in this particular area of law.

Is Asset Protection Legal?

There are both legal and illegal means of protecting your assets.

Aside from engaging in a fraudulent transfer, there are a few other illegal things you should avoid in asset protection law. These include:

• Concealing your assets from the courts during a bankruptcy or other proceeding.
• Refusing to hand over your assets after you have been ordered to do so by the courts (i.e. contempt).
• Hiding your assets from the IRS or other tax collecting authorities (i.e. tax evasion).

It shouldn’t be too difficult to see why these methods of asset protection are illegal. However, that does not mean that all asset protection is illegal, and there are a great many other strategies which you are fully permitted to do. This article is designed to outline a few of those strategies.

Is Asset Protection Ethical?

This can be a thorny question for some clients. Many people consider it a personal point of honor to pay their debts, no matter how they may have been incurred.

However, the question is not always so simple, and contrary to popular stereotypes, the creditor side of the equation is not always honest or straightforward.

We live in an increasingly litigious and victim-centered society. In such a society, just about anyone is at risk for a frivolous lawsuit being filed against them. And while the hope is that most frivolous lawsuits are thrown out by the courts, the practical cost of fighting them can be so high that settling is often the only feasible option.

Once you have a judgment or settlement against you, the lawyers on the creditor side will kick into action… and they have elevated debt collection to an art. They will put a lot of thought into eking as much money as they can out of you. It’s only reasonable that you put a bit of thought into defending yourself against these tactics.

Most people would agree that it’s honorable to pay your debts – but there is nothing unethical about refusing to pay money that you do not legitimately owe. If anything, you have a moral obligation the other way: to fight as hard as you possibly can for your assets so that your children and other heirs are not shortchanged.

In short, the process of debt collection itself is value-neutral. Don’t buy into the narrative of the heroic creditor and the villainous debtor. Sometimes the story does indeed unfold this way, but it is just as common for the heroes and villains to be reversed, and when this occurs the debtor has every moral right to take all the appropriate steps to protect their assets.

Who Is Most in Need of Asset Protection?

Just about anyone can lose their assets. No one is immune from a lawsuit, and so everyone should put some thought into the matter of asset protection.
However, a few groups are uniquely at risk.

First of all, wealthier people need to do more to protect their assets than anyone else. The reason why should be obvious: wealthy people have targets on their backs for frivolous lawsuits and other claims. They have more to lose, and people feel less compunction about robbing the rich than the poor.

Certain professions are also at especial risk. These include doctors, dentists, and lawyers (yes, even us), all of whom are at high risk for facing a malpractice lawsuit at some point in their careers.

Real estate agents and investors are also at a high risk, as they are working in an industry which is especially cutthroat.

If you are in one of these industries, then you will have to give extra thought to the matter of asset protection.

Steps to Take in Order to Protect Your Assets

Asset protection involves a wide and complex body of intersecting laws. We can’t go over all the factors here. However, we can provide a broad overview of some of the fundamental steps that you should take to protect your assets. Keep in mind that much will depend on your individual situation.

Step 1: Choose the Right Type of Business Entity

If you are going to start a business, there are several different types of business entity that you can create.

Which is best for protecting your assets? In most cases, the best option will be a corporation or a limited liability company (LLC). This is because both corporations and LLCs have what is known as a shield of liability: even if the business is sued, the owner is not personally liable for the damages. The plaintiff is only able to collect assets that are within the business itself.

Other business structures, such as sole proprietorships and general partnerships, do not have the shield of liability. If you are sued as a sole proprietor, then you can be sued for everything you have. A partnership is the same. (In fact, it’s even worse, because you may be liable for the actions of your partner.)

If you own real estate, then you may also place the real estate into an LLC. If you do this, then someone who claims that they were injured on your property can only recover damages from the LLC.

You must generally have a legitimate business purpose for placing the real estate in the LLC, which means that you cannot protect your own house in this way.

Of course, when you set up a corporation or LLC, you will need to be very careful to keep personal and corporate funds separate. If you mix the two, then this may breach the shield of liability and open you up to being personally liable. Keeping these funds separate will require a high degree of diligence on your part.

Step 2: Give Your Spouse Control of Your Assets

Generally, property acquired during a marriage is jointly owned. However, if you are at a higher risk than your spouse of losing your assets (for instance, if you are a doctor or a real estate agent), then you may give these assets to your spouse who does not face the same level of risk. These assets will then become the personal property of your spouse, and will be much harder for a creditor to get their hands on.

This is a very simple and effective step to take, but it has a couple of major risks. First of all, as we already mentioned, this must be done well in advance of your incurring any debts or else it may be considered a fraudulent transfer.

Second, this strategy requires you to place a good deal of faith in your partner. If your relationship with your spouse is strong, then there should be no problems. However, if you and your spouse divorce, then your spouse will get all of the assets that you have given them. You will not be entitled to half of the assets like you would if they were your joint property.

Even if your marital relationship is strong right now, the sad truth is that many marriages deteriorate very suddenly. You do not know what could happen a few years or decades down the line, so it is worth thinking very carefully (and not just about finances, either) before using this strategy.

Step 3: Create an Asset Protection Trust

Trusts are primarily a tool used for estate planning, but it is also possible to create a trust for the purpose of asset protection. Such a trust is often self-settled, which means that you are the beneficiary as well as the settlor of the trust.

There are two main types of asset protection trusts: domestic and foreign.
A Domestic Asset Protection Trust (DAPT) is, as the name suggests, formed within the United States. The laws regarding this differ from state to state, and California is generally not friendly to DAPTs. However, you may still have the option to create a DAPT in another state, so long as you designate a trustee within that state. The states with the friendliest laws for setting up DAPTs are Alaska, Delaware, Nevada, and South Dakota.

A Foreign Asset Protection Trust (FAPT) is set up in a jurisdiction outside the United States. Setting up a FAPT does not excuse you from your legal obligation to pay taxes in the United States, but they can be legally used to protect assets. There are a few jurisdictions which have made themselves havens for FAPTs, but the Cook Islands (a small archipelago nation near New Zealand) are by far the best option.

Asset protection trusts, both domestic and foreign, can make it much more difficult for a creditor to take your money. However, they do not provide absolute protection. Under some circumstances, the courts can still demand that you surrender the assets that you hold within a trust, and if this occurs you must comply or face legal consequences.

All things considered, though, it is much better to have an asset protection trust than not to have one.

Conclusion

This is an overview of asset protection strategies, but it is not the full story. Any asset protection plan must necessarily be tailored to your individual circumstances and whatever unique needs you have.

When devising an asset protection strategy, you walk a delicate balance. The strategy must be fairly complex if it is to be effective. At the same time, it cannot be too complex, or else it will end up trapping you in a maze of your own creation in which even you cannot figure out where all of your assets are.

Furthermore, because engaging in the wrong forms of asset protection, or even engaging in the right forms of asset protection at the wrong times, can land you in serious legal trouble, then it may be a maze full of tripwires. One minor mistake can get you branded a fraudster.

Although we don’t doubt that you have legitimate reason to protect your assets, the court system is not generally forgiving of debtors. Judges and juries tend to buy into the stereotypes of creditor-as-hero and debtor-as-villain that we addressed above.

For these reasons, asset protection is not something that you should do unassisted. If you are someone who is financially successful enough to have assets worth protecting, then you are likely extremely busy and you probably do not have time to give asset protection the consideration that it may merit.

This is why you will likely need the help of an asset protection attorney. By outsourcing your expertise in this area to someone who knows how to best protect your assets, you can rest easy knowing that you have made yourself as safe as you possibly can.