Part One of “Protecting Assets from Lawsuits and Judgments” described the many kinds of personal and professional liability that can make somebody susceptible to judgments and lawsuits. We also provided some tips on protecting your assets from judgments or lawsuits with proper insurance and business entities.
Now, we’ll detail more strategies to protect your cash, your investments, and your home from lawsuits and creditors.
3. Protect Your Cash Stash: Save Money Safely
A savings account is NOT a safe place to store your cash! (Even without creditors and lawsuits, a bank account is NOT the safest place to put your money.) Aside from offering significantly low interest rates, bank accounts often get reported to the IRS and are accessible by creditors—even without your foreknowledge, in some situations. Saving a lot of money in conventional bank accounts can actually make you a target!
Three financial vehicles often used to keep cash safe from harm are Retirement Accounts, Cash Value Accounts (part of a whole life insurance policy), and Annuities. Let’s take a look at each.
Many people are aware that qualified retirement accounts such as 401(k)s and IRAs (usually*) have protection from creditors and lawsuits. This protection can extend up to $1 million, as provided for in the Bankruptcy Reform Act. These can be good choices for a portion of your savings when you are nearing 59.5. You may also want to take advantage of an employer match. However, the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) made several changes to reduce business and consumer bankruptcy abuse.
Protections depend on the IRA type, with Roth and traditional IRAs protected up to $1,362,800. There are inflationary adjustments every 3 years, with the next change due in 2022. Regardless of the total dollar value, rollover IRAs, SEPs, and SIMPLE IRAs receive full protection from creditors with a bankruptcy filing. Furthermore, with the Covid Bankruptcy Relief Extension Act, if you own a business, the debt limit is now $7.5 million for small businesses that file under subchapter V.
What’s more, with Biden’s 2022 budget proposal and capital gains tax hike, high-income investors are shifting their attention to Roth IRAs. This is because a Roth IRA allows you to contribute after-tax dollars, giving investors tax-free withdrawals. This is a great illustration of the importance of paying taxes when you know what they are, as opposed to differing them to an unknown future rate.
Should You Max It Out?
Just because you hear again and again to “max out your 401(k)” doesn’t mean it’s the best advice. Putting your cash where YOU can’t get to it may make it safer from lawsuits. Yet, it doesn’t do enough to increase YOUR financial certainty in the meantime. It’s crucial that at least a portion of your savings is available and accessible to you when you need it. And unfortunately, neither your 401(k) or your IRA are particularly liquid. (See our articles on “Financial Flexibility: Saving Too Much in All the Wrong Places” and “Saving Right: Is Your Emergency Fund Prepared for Opportunities,” for more.)
(And we’re not sure that plaintiffs are your biggest worry when you could lose 30, 40, even 50% of your retirement account in a single year to “the market.”)
So… where ARE your assets safe from lawsuits and creditors?
Whole Life Cash Value Accounts
Cash value accounts in a properly structured whole life insurance policy are (usually*) one of the most certain places you can store your cash. (You may also hear this insurance called participating whole life, dividend-paying whole life, mutual life insurance, and permanent insurance.)
Cash value accounts typically provide an internal rate of return many times higher than what banks provide. It might be 4.5% or higher (after 20 years). In the example above, for a 45-year-old non-smoking male, see the last two columns at Year 20 and Year 30 for estimated IRR. In some cases, cash value might exceed 5% (depending on your age) with even greater safety and no risk of principle as in market-driven vehicles.
While some years may be lower, consider this: once your cash value increases, it cannot decrease (unless you withdraw–here’s what we recommend instead). While receiving a dividend is not guaranteed, the floor of your cash value is guaranteed to increase each year. And historically, dividends have been distributed even in great economic turmoil. That’s more than can be said for the stock market.
There are other benefits, such as tax-advantaged treatment (gains are not taxed as long as the policy is maintained), and the ability to use funds or borrow against them with no qualifying hoops to jump through (an essential benefit for entrepreneurs and investors). And in most states*, cash value accounts are protected from judgments, lawsuits, and even from IRS knowledge.
A type of investment that returns a steady, guaranteed income, annuities are (usually*) protected against lawsuits and creditors. Annuities are also a life insurance product, and as such, they are protected against market fluctuations. When someone purchases an annuity, they exchange a sum of money for regular payments guaranteed for a certain length of time, or, in some cases, for the remainder of a lifetime.
While annuities are extremely safe (in most states) from plaintiffs or creditors, they don’t have the flexibility and benefits of whole life insurance. (For reasons a bit beyond the scope of this article, we don’t often recommend annuities for our clients. We’re happy to discuss why and offer alternatives in a complimentary consultation.)
*We say “usually” or “most states” because laws do vary—sometimes significantly—from state to state. Before you commit to any asset protection strategy, it is important to verify the specific laws in your state or jurisdiction as to which assets (and how much) are exempt. (And remember… if you move to a new state, check their laws as your protection may change dramatically.)
Helpful tools include the Asset Protection Society, which has a 50 State Asset Protection Chart and Duggan Bertsch for legal expertise. (However, don’t stop there—verify independently that the information is up-to-date for your state!)
4. Protect Your Home (and other property) from Lawsuits and Judgments
Some states provide protection for home equity, which means that courts cannot award your home equity to creditors in the case of bankruptcy.
An example is if you owe $20,000, and a bank sues and obtains a judgment against you. They cannot forcibly sell your home if your home equity is under your state’s exemption limit. In state-X, the exemption is $50,000 and your home’s value is $400,000 with a $370,000 mortgage balance. The $30,000 falls below the exemption limit.
Check your state’s laws to see if they provide a generous homestead exemption to protect the equity in your home from creditors. (However, don’t consider this a safe haven or liquid. We caution clients against thinking of “equity” as an “asset.” You can lose access to the equity and cash if your property values fall.)
Currently, Florida has an unlimited homestead exemption. However, exceptions might include the length of ownership and acreage. States with generous exemptions include Montana $250,000, Minnesota $390,000-$975,000 for farms, and Nevada $550,000 equity. States that have minimal exceptions include Oklahoma, Texas, Iowa, South Dakota, and Kansas. Albeit they allow some type of tenancy, states with no exemptions include Pennsylvania and New Jersey.
Alternatively, if your state provides a minimal homestead exemption, it may make sense to keep a large mortgage on your home. This might discourage anyone from coming after your home. Free-and-clear assets are more vulnerable. This is also worth noting if you have a business and file as sole proprietor instead of LLC or LLP.
The way you have a property titled can have critical ramifications in the event of a lawsuit or judgment.
For instance, if you own your home with your spouse as tenants by the entirety, both you and your spouse own an indivisible interest in the home. If one of you is sued, creditors cannot force the other spouse to sell his or her interest in the house. This can help protect your home in a state where the law doesn’t provide a sufficient homestead exemption. (This option is only available in some states, and it applies only to your personal residence, not investment property.)
If you are divorced, and your ex isn’t paying the mortgage, you may have options in lieu of bankruptcy. Review the final order you received from the divorce court about equity in the home. Talk to a lawyer about if a judge can put the property in your name so you can sell it.
Tenancy by entirety can protect your home from personal or business creditors who win judgments against you, as a judgment cannot be placed against one spouse unless both are held jointly responsible. Other forms of titling include tenancy in common and joint tenants with rights of survivorship. Speak to a lawyer licensed in your state, well-versed in both real estate and asset protection, for specifics concerning your situation.
If you live in a state where community property laws apply, gifting property to your spouse (for instance, if you own a business that could make you a target and they do not) may make sense. In that case, a married couple is considered to own all property acquired during the marriage jointly, even if assets are titled in only one spouse’s name.
In other instances, gifting property to heirs while you are still living in it may be a workable strategy. Of course, you must clarify in writing provisions for you to retain use, and you must also carefully consider that heirs may become subject to lawsuits, as well!
A gifting strategy is useful for protecting and transferring other family assets. Creditors cannot seize assets that you no longer own. If you don’t expect to need the money while you’re alive, you might benefit from your family enjoying the early inheritance. Limited assets can be gifted to family members outright, without a trust. As of 2021, with the Gift Tax Exclusion, you can give away up to $15,000 per person without incurring a gift tax liability, subject to a lifetime exclusion of $11.7 million. The giftable amount is $30,000 for couples (split as $15,000 each).
Taxes on Gifts
If you gift more than the exclusion to a recipient, you will need to file tax forms to disclose those gifts to the IRS. You may also have to pay taxes on it. If that’s the case, the tax rates range from 18% up to 40%. However, you won’t have to pay any taxes as long as you haven’t hit the lifetime gift tax exemption. A concern is how to gift if you have more than one recipient. In this case, you will need to disclose these gifts in tax forms to the IRS. The tax rate is 18-40%. However, you won’t pay taxes if you have not reached the exemption limit.
Let’s say that this year you give $315,000 to relatives. This is $300,000 over the limit and you should report it when you complete your taxes albeit the tax isn’t immediately due. The IRS simply subtracts the $300,000 from the lifetime exemption. Hence, your remaining exemption drops from $11.7 million to $11.4 million.
Gift Tax Limit: Lifetime
Most taxpayers won’t ever pay gift tax because the IRS allows you to gift up to $11.7 million over your lifetime without having to pay gift tax. This is the lifetime gift tax exemption, and it’s roughly $120,000 higher than it was in 2020.
So let’s say that in 2021 you gift $215,000 to your friend. This gift is $200,000 over the annual gift exclusion. That means you will need to report it to the IRS. However, you won’t immediately have to pay tax on that gift. Instead, the IRS deducts that $200,000 from your lifetime gift tax exemption. Assuming you have never made any other gifts over the annual exemption, your remaining lifetime exemption is now $11.5 million ($11.7 million minus $200,000).
5. Protect Assets Long-Term with a Trust
Trusts can be used to control what happens to your assets when you are gone. Even so, they can also be a way to protect assets from lawsuits and creditors while you are living. Irrevocable trusts allow you to remove assets from your estate. If assets are a part of your estate, creditors can obtain access to them with a judgment.
Irrevocable trusts can be created directly, or revocable trusts can be converted by default. A revocable trust will automatically revert to an irrevocable trust upon your death. At that point, the trust cannot be changed and the creditors of your estate cannot come after the assets that are in the trust, even when distributed to beneficiaries.
The process of setting up a trust that can stand up to creditors and lawsuits will require some professional help. We recommend consulting a reputable estate planning lawyer if you are considering setting up a trust.
6. Never Give Assets Away without a Fight!
A lot of people believe that if you owe a creditor money or have a judgment against you, there is nothing you can do to fight it. This is not true! Companies typically write off or ”charge-off” debts as losses after 6-months of non-payment. However, consumers are still liable and responsible for paying the debt. Some banks will sue consumers for non-payment and because the consumer doesn’t answer a complaint summons, the bank can obtain a default judgment in the full amount. Another concern is third-party debt collectors. They often buy the debt for pennies on the dollar and pursue the debt, sometimes aggressively through judgments against consumers for inflated amounts.
Sadly, most consumers do not even fight these creditors, unaware that oftentimes the third-party creditors do not even have the proper paperwork to win a judgment if challenged. Many will disappear if you simply ask them to validate the debt. Some are not even licensed to do debt collection in your state! Others may be legitimate, perhaps even working for the original creditor. Still, they may likely negotiate solutions. However, it is much easier to negotiate a solution before a judgment than after a judgment has been won against you.
Negotiating Your Debts
With asset protection and financial advising, you may want to seek advice on negotiating debts to get you back on track financially. Consumer credit counselors may help lower your interest rate. You may also find success in asking a creditor to negotiate a lower payment to avoid future lawsuits. They will sometimes deduct up to 30% off the original balance due and set up payment arrangements if you want to pursue this option yourself. This article from Nolo.com may give you some more direction: “Negotiating on Credit Card Debt.” It includes advice on how to set up payment dates, negotiate long-term payments, set up settlements and ask for lower interest rates. National Debt Relief offers debt relief assistance, while Nerd Wallet explores sample debt relief settlement options.
The Best Defense is a Good Offense
Sort of like insurance, asset protection, and personal finance strategies are best employed before there is a problem. Asset protection involves both financial and legal expertise, and if you have significant assets, you will want to consult a financial advisor licensed in your state, as well as an estate planning attorney.
Is it time to implement a strategy to protect your assets against lawsuits or creditors?
At Prosperity Thinkers, we’re here to help you create good money methods and save more sustainably. If we can help you to start saving with whole life insurance, we’d love to hear from you. Read about our clients to see if we might sound like a match.