Asset Protection

by: Christopher T. Craig

Asset protection planning involves titling (or re-titling) assets so that their form of ownership minimizes or eliminates exposure to unforeseen liabilities. Proper asset protection planning MUST be done prior to the onset of a claim, lawsuit or even the threat of such action. If the threat (or claim) has already emerged, asset protection planning may be deemed a fraudulent transfer, and could negatively impact available protection. Asset protection planning may, at times, conflict with estate, tax and other financial planning. For example, it may be beneficial to own an asset jointly for one purpose, and separately for another. When such conflict arises the client will be required to prioritize which planning option is most important.

Several asset protection techniques exist that do not require great effort. For example, assets held in most retirement or deferred tax plans (e.g., 401(k)s, IRAs (up to $1,245,475 in 2016), and 529 savings plans) are either not subject to creditors’ claims, or such claims are limited. In addition, married couples may own real estate or personal property (e.g., bank accounts, stock accounts) “tenants by the entirety” (T/E). When an asset is owned T/E, it is not subject to claims against either spouse, individually (other than Internal Revenue Service and state income tax claims). This protection does not apply to the spouse’s joint debts.

Finally, as a general matter, in 2016 the Virginia General Assembly adopted a law providing an exemption from creditor claims against the proceeds and other benefits from insurance policies and annuities. This law may allow life insurance policies and annuities to become asset protection tools. However, there are restrictions on the assets if they are obtained with the objective of defrauding creditors or within six months of filing for bankruptcy.

Asset Protection Trusts

Another asset protection technique is to create a trust designed specifically to protect assets. Under Virginia law, Virginia residents may establish a trust for their own benefit using their own assets that will be exempt from creditors’ claims. This trust is known as a Virginia Asset Protection Trust, or the Virginia Self-Settled Spendthrift Trust. Under this law you can create a “qualified self-settled spendthrift trust,” provided that, among other things:

1. The trust is irrevocable (in some very limited circumstances an irrevocable trust can be reformed or modified by judicial order or consent of all of the parties to the Trust, including the settlor, beneficiaries and trustees);
2. Funding of the trust does NOT make the settlor (creator of the trust) insolvent. Settlor should transfer some assets to the Trust while retaining sufficient assets to meet current financial obligations. Likely assets could include passive investments (stock) or Virginia rental real estate;
3. A Virginia trustee is named whose duties are to maintain custody in Virginia of some or all of the trust property; maintain records in Virginia; prepare Virginia fiduciary income tax returns; and otherwise materially administer the trust in Virginia;
4. The Trustee must be a resident of Virginia, or a Trust company (e.g., a Bank trust department) that is licensed and domiciled in Virginia; and
5. The settlor (you two) must be entitled only to discretionary distributions of income and principal; and
6. Any transfers made to the trust may not be fraudulent (designed to defeat current creditors).

Other features of this trust include: (i) for a five-year period after funding, creditors existing at the time of the creation of the trust may bring a claim; (ii) the settlor may not retain a power to disapprove distributions; and (iii) the person or entity who approves distributions must meet certain requirements for a qualified trustee (e.g., the independent trustee cannot be spouses, descendants, siblings, parents, or employees, or entities in which the settlor controls thirty percent of the vote). Concerning this latter requirement, Virginia is rather conservative with its restrictions, as other states are generally less restrictive as to who can act as a co-trustee or ‘distribution director’.

It should be noted that this Trust will only protect assets not yet received as a distributions (either income or principal) from the trust, and a Virginia self-settled spendthrift trust does not provide protection against IRS or Virginia tax obligations, or child support. Other issues to consider would be whether to make the trust a “Grantor Trust,” allowing the income in the Trust to still be part of the Settlor’s personal tax return and ensure that no taxable gift is made at the time the Trust is funded, thus providing a tax-free benefit to the trust beneficiaries.

Other types of trusts that may protect assets include Qualified Personal Residence Trusts (QPRT) and Qualified Terminable Interest Trusts (QTIP). A QPRT is an irrevocable trust (with an independent trustee) designed to reduce gift and estate tax liabilities related to real property. The asset protection feature is tied to its irrevocability and inability to amend. Trusts of this nature can protect the real property in the trust by removing it from the settlor’s estate and passing it to beneficiaries. The law sees it as a valid legal method to protect an individual’s assets for their beneficiaries. That said: if asset protection related to real property is the goal, the ownership T/E by a married couple will mostly solve that issue while both spouses are alive.

A QTIP allows a married couple to structure the transfer of assets upon the death of the first spouse so that the surviving spouse can take advantage of the estate tax marital deduction, give the surviving spouse control over the distribution of assets, and protect the assets included in the trust from the creditors of the surviving spouse. This type of trust could be drafted into a will and created upon the event of the first to die. During the joint lifetimes of the spouses all assets owned T/E would be protected, and after the first to die, all assets distributed into the QTIP would be protected from the surviving spouse’s creditors.

If you have any needs related to this article, or any other estate planning please contact our office to make an appointment.