Asset protection refers to keeping one’s assets safe from being claimed by creditors. Creditors are people or entities who are owed money, including those who have been awarded malpractice or other legal awards.
According to Virginia attorney Wayne Zell, asset protection planning is extremely important for medical practitioners and in particular for those practicing in fields that are susceptible to malpractice suits.
There are a number of tools that can be used to protect assets. Here we briefly discuss: pension and retirement investment accounts, malpractice insurance, irrevocable trusts, titling assets as tenants by the entirety, homesteads, asset protection trusts and offshore trusts, prenuptial agreements, and life insurance and annuity contracts. A given tool may be effective against specific creditor categories but not others, and protections may not be absolute.
Pension and Retirement Investment Accounts
Generally, pension assets and qualified investment accounts such as 401(k) and 403(b) plans are protected from bankruptcy creditors. Roth and Traditional IRAs also have some protection. There are some exceptions and limits to these protections so make sure you’re obtaining advice from an expert.
Malpractice liability is a serious risk for physicians, although the exposure differs by specialty area. Insurance against malpractice exposure is a necessary part of any doctor’s risk management toolkit. With proper protection, the malpractice insurance company pays attorney fees and judgments, instead of the funds coming from the physician’s personal assets. Malpractice insurance is discussed in the employment contracting chapter of this book.
Irrevocable Trusts are discussed earlier in this chapter. The key with such Trusts is that the grantor is required to give up control of any assets placed in the Trust. Since the grantor has effectively given these assets away, they now irrevocably belong to the Trust. While a doctor may be found liable professionally or personally, a Trust—a distinct legal entity outside the doctor’s control—is not automatically guilty of any wrongdoing or malpractice. Therefore, as the logic goes, the Trust’s assets should not be available to creditors.
Tenancy by the Entirety
This is a form of joint ownership of an asset which only applies to married couples. Tenancy by the Entirety has a crucial condition—that neither owner alone can “sever” the joint tenancy. Let’s assume the jointly owned asset in question is a real estate property. Then neither spouse can make a unilateral decision to sell, donate, give as a gift or otherwise transfer their share of the property to another person. Property held in this way may be protected from creditors of one spouse on the grounds that it’s unfair to financially damage the other (presumed innocent or non-liable) spouse.
Tenancy by the Entirety may not be recognized in all states.
Legally, a homestead is a house (and land) in which a family resides. A family home may have some protection from creditors. These rules vary significantly from state to state, ranging from very significant protections, to no protections at all.
Asset Protection Trusts & Offshore Trusts
Some states, such as Delaware and Alaska, offer Asset Protection Trusts, which may be available for non-residents. Under some conditions, asset protection Trusts may provide a higher level of protection than traditional in-state Trusts, but they are also more expensive.
One may pursue even greater asset protection by arranging for an Offshore Trust, i.e., a Trust set up under the laws of another country. Offshore Trusts can be extremely expensive to set up and therefore only likely to be relevant for wealthier households.
In this discussion we’re focusing on asset protection. Offshore trusts are often viewed suspiciously as efforts to evade taxes and therefore come under greater scrutiny by US officials. Make sure you receive the highest quality legal advice if you seek to pursue these asset protection mechanisms.
Prenuptial or premarital agreements, often referred to as prenups, are contracts entered into prior to marriage or civil union which outline the disposition of assets, spousal support, and guardianship over children.
Prenups are not enforceable in all 50 states.
The romantic vision of marriage is one of equality. Prenups tend to favor the partner who has more assets and create an uncomfortable situation in which one spouse is “more equal than the other.” An obvious challenge when it comes to such agreements is that their mere suggestion is often viewed as a lack of commitment to the relationship.
A big challenge for couples is that after signing well-drafted prenup agreements, they often inadvertently commingle assets. For example, they buy property or open a bank account jointly. Such actions defeat the purpose of separation of ownership dictated by the agreement in the first place and may invalidate some or all of its terms.
Life Insurance & Annuities
In some states life insurance policies and or annuity contracts have some asset protection features. For example, the cash value of permanent life insurance policies or the proceeds of annuities may be protected from some creditors. Make sure you fully understand the protections available to you in your state.
According to Wayne Zell, placing a life insurance policy in an Irrevocable Trust (Irrevocable Life Insurance Trust or ILIT) can provide two layers of protection, as long as the Trust is properly drafted and administered. Such arrangements can also help to achieve income tax and estate planning objectives, making them potentially useful estate planning tools.