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Asset Preservation:

Legal Strategies Which Protect Against Future Lawsuits

Your daughter's boyfriend wrecks your car. Your tenant gets mugged outside his apartment. A child is injured playing in your condo's pool. You guarantee a friend's loan and he doesn't pay. You know what happens next: You get sued.

In some cases, insurance provides a first line of defense. But even then, the judgment may exceed policy limits, or even worse, the insurer may prove insolvent. Many people now pursue deliberate strategies of asset protection in order to avoid unnecessary risk to homes, bank accounts, and other assets.

Advance Planning is Essential
As Mark Twain once observed: When you need a friend most, it is too late to make one. This is especially true in the context of asset protection. In the course of ordinary financial management, asset protection strategies are perfectly legal. However, when faced with the threat of an imminent lawsuit, they are not.

Asset protection planning is essentially organizing one's assets and affairs in a manner, which affords protection against future judgments. Many techniques are available to screen assets, and they vary widely in terms of cost, suitability, and the degree of protection afforded. Several of the more popular strategies are summarized below.

Offshore Asset Protection Trusts
Offshore trusts were once the preferred money-hiding gambits of financial criminals and con men. Today, however, the offshore asset protection trust (OAPT) is a legitimate, and effective legal strategy provided it is not being used to conceal assets or defraud creditors. Many small, capital- hungry nations have passed laws allowing foreigners to place cash and securities in trust within their borders. Most noted for such laws are the Bahamas, Belize, the Cayman Islands, the Cook Islands, Cyprus, Gibraltar, and the Turk and Caicos Islands.

In essence, an OAPT is a trust created under the laws of a foreign jurisdiction. American courts will generally defer to the trust laws of the foreign nation provided a trustee resides there. In addition to this foreign trustee, whose power is usually strictly limited, one or more domestic trustees--usually friends or relatives--will actively manage the trust. When properly used, an OAPT will protect assets from future creditors, maintain confidentiality and avoid probate.

However, OAPTs are not without disadvantages. They carry heavy start-up costs--often in excess of $15,000. Also they are only suitable for highly liquid assets like cash, stocks, and negotiable securities. Further, any such assets held offshore are subject to the potential political volatility of these small, sometimes unstable nations.

Domestic Trusts
Most individuals seeking asset protection utilize some form of domestic trust. American laws place much greater restriction on the level of benefit and control, which may be retained by the creator of a trust. The time honored maxim is: One does not place property beyond the reach of creditors unless the property has been placed out of the transferor's own reach.

The legal reality is that, once a trust is declared invalid, any assets it contains may be reached by creditors. Thus, domestic trusts require a substantial trade-off in control in order to achieve asset protection. Nevertheless, many feel the benefits outweigh the associated costs. Here a two examples of commonly used domestic trusts:

  • Irrevocable Life Insurance Trusts allow you to transfer ownership of your life insurance policy to your spouse or children. This is an excellent strategy for those with very large policies because the proceeds are removed from the taxable estate. It also protects the policy from creditors because ownership is vested in another party. Of course, this can lead to complications if you change your mind about who should receive the death benefit.
  • Grantor Retained Income Trusts (GRITs) let you place assets, such as your home, into trust for your children while retaining right of use for life. This effectively places the asset beyond the reach of a creditor, but also sacrifices virtually all control over the property. There are, however, other significant estate planning reasons, such as tax savings, which make GRITs attractive.

Family Limited Partnerships
Family limited partnerships (FLPs) are similar to regular limited partnerships, but typically hold the assets of a single family. The general partner retains control over the partnership assets, and the liability of the other partners is limited to their equity interests. By placing restrictions upon the partner's ability to withdraw or force dissolution, the partnership form becomes an almost impenetrable shield against the creditors of the limited partners.

FLPs are frequently used to pass rental properties or a family business to children or grandchildren, thereby reducing estate taxes. They are not, however, effective strategies for protecting other types of assets. They can also be very expensive to form and maintain, but in the right situation, they are an exceptional way to protect assets and transfer wealth without incurring estate or gift taxes.

Post-Nuptial Agreements
A post nuptial agreement is a contract between spouses made during marriage. The purpose of the agreement is to convert community property into separate property thereby protecting assets from "community creditors." The assets held separately by each spouse cannot be reached to satisfy the debts of the other spouse. Of course, one major drawback to post-nuptial transformation of property is the possibility of divorce. Once transformed, separate property will remain separate property. So couples should carefully consider the consequences before entering any such agreement.

Which is Best?
The right strategy depends on a number of facts. The type and value of assets, the long- term objectives, the extent of residual control required, and the nature of perceived risks all influence the decision. Frequently, the best choice will be a hybrid of several strategies. But which ever technique is used, careful advance planning is the key to protecting assets from unexpected and sometimes unjust attack.

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