Asset Protection - Retain Your Wealth

 By: Charles Benninghoff
Asset Protection is everyone's desire, but adults share a characteristic - that they may be sued at anytime, for any reason, whether founded or not.

Civil actions range from the serious to the frivolous. Did you offend someone today with something you said? Did you cause someone to suffer sudden whiplash syndrome in the parking lot? Are you a professional facing a disgruntled client or patient? Do you own a company employing someone who did something irresponsible on company time? Did you err on the side of caution... or throw caution to the wind?

Each choice you make might be construed as "actionable." That is, someone might spin a good case - or at least a good story - about how you crossed a line in some way, and why you should now pay dearly for your failing.

Sadly enough, the more money you have the more tempting a litigation target you are. And you are an even riper target if you value privacy in your affairs. The "discovery" phase of litigation will put an end to your uncivil habit of protecting personal information.

What Can be Done?

There are proven strategies that will ethically preserve your wealth and keep the vultures at bay. Your most powerful weapons in this fight will be a variety of estate planning tools, including the Family Limited Partnership, the Irrevocable Life Insurance Trust, the Children's Trust, and Foreign Asset Protection Trusts.

The Children's Trust

One way to place assets beyond the reach of potential plaintiffs is to transfer property to your children.

You've probably been acquiring an estate not only for your benefit while you are alive but also to help your children and grandchildren. The IRS will allow you to give up to $13,000 per person per year absolutely free of gift tax. If both spouses join in the gift, you can give up to $26,000 a year, gift tax-free. (As indexed for inflation)

By giving property to a Children's Trust each year, you can shift the income from your high tax bracket to the lower tax bracket of your children or grandchildren who are age 14 and older. Unfortunately, children under age 14 must pay most of their taxes at the same rate as their parents.

Once the Children's Trust is sufficiently funded, it can pay the cost of a child's education. That way the expenses are paid with discounted tax dollars. (However, remember that parents or grandparents can pay tuition costs directly as a tax-free gift.)

If you own a business, you can gift its equipment and furniture to the Children's Trust and have the Trust lease it back to the business. Under this plan, the business gets a legitimate tax deduction, and the rental income is earned by the Trust potentially at lower tax rates. Plus, the benefit of the depreciation is given to the trust.

Having a Children's Trust or a Family Limited Partnership also promotes family investment values. The children now have an identifiable stake in the family's financial success. It goes a long way toward helping them understand the value of money and wise investments.

The Children's Trust has probate avoidance and estate tax reduction benefits. All assets transferred to the Trust are no longer a part of your estate. That means when you die, those assets will not go through probate and they will not be subject to federal estate tax.

The Irrevocable Life Insurance Trust

You probably already know several reasons why life insurance is important. Young families need it to replace part of a breadwinner's income. Mature Americans find it provides their heirs with a source of funds to pay estate taxes.
Life insurance can do all this and shield assets from litigation at the same time. How? By use of the Irrevocable Life Insurance Trust (ILIT). An ILIT is a good idea even if you don't worry about suits or creditors, because it allows the full value of your life insurance to pass tax-free to heirs. Without an ILIT, the government will count the face value of an insurance policy in calculating your taxable estate. Anything over the estate tax exclusion (the exclusion is $3.5 million in 2009. In 2010, the estate tax is repealed only to return in 2011 with a $1 million exclusion) is subject to "death tax" rates ranging from 41% to 55%.
When you set up your ILIT, you name a trustee other than yourself, most likely a beneficiary. The trustee purchases a life insurance contract on your life with funds you provide. If you have an existing policy, you can assign ownership of it to the ILIT, but there are conditions imposed on these transactions that should be carefully considered before you do so.

The ILIT gives you control over how proceeds from your life insurance policy are spent. You control who receives the proceeds and how they receive them. Whatever distribution strategy makes most sense for you and your loved ones, the ILIT gives you the opportunity to put it in effect.

And, of course, it has important asset protection benefits. Over the years, your premiums and interest earnings can accumulate to considerable sums, making cash value policies a tantalizing target for creditors. When the policy is owned by the ILIT, it is out of the reach of creditors.

Family Limited Partnership
A Family Limited Partnership (FLP) is one of the most popular estate tax and asset protection planning devices. An FLP is simply a limited partnership similar to the real estate or business operating limited partnerships with which many are familiar. When you transfer your business and investment assets into an FLP, you receive in return:

General Partnership Interest: Generally, you receive just two percent of the total partnership interests in the form of general partnership interests. That means that you control all of the decision-making for the FLP's activities.

Limited Partnership Interest: You receive the remaining 98% of the FLP in the form of limited partnership interests. Limited partnership interests give the limited partner very limited rights in partnership income and activities. While general partners may not treat a limited partner unfairly, a limited partner essentially has no meaningful control or rights.

Now what happens? You will give your children some of your limited partnership interests. That means that the partnership has partners other than just you.

As a general partner, you have complete control and access to the assets and income of the FLP in accordance with terms you designed. If you have given your children ten percent of the FLP, they are entitled to ten percent of any distributions that you decide to make, but they cannot force you to make any distributions.

How Does the Asset Protection Benefit Work?

If you are successfully sued, all the plaintiff is able to receive is a "charging order." That's a judgment against the partner that tells the partnership that any distributions of profit that would otherwise be made to the debtor partner must instead be paid to the plaintiff/creditor. But the plaintiff has no power to interfere in partnership matters.

The charging order is a very hollow victory. Because the general partners decide if profit is to be distributed to the partners, the general partners can withhold distributions for partnership purposes and the creditor receives nothing.

Obviously, the creditor does not just go away, but because the charging order provides so little leverage, creditors frequently settle the claim for less than face value. Those who might consider filing an unjustified lawsuit may change their minds when they realize that all they will receive is a hollow charging order.

Foreign Asset Protection Trust

The ultimate asset protection tool is a Foreign Asset Protection Trust.

In many ways a Foreign Trust looks exactly like a domestic trust. The Trustor is you, the person who transfers the assets to the Trust. The Trustee is a Trust company, experienced in asset management, whose business is operated outside of the United States in a jurisdiction that does not recognize United States judgments.

In a typical Trust, the Trustee is given discretion to accumulate or distribute Trust income among a specified class of beneficiaries. You may be one of the named beneficiaries, together with your spouse, children, or grand-children.

A unique feature of this kind of Trust is the role of the "Protector." The Trust protector is a person who has the power to take virtually any actions necessary to protect your Trust. The term of the Trust may be limited to a period of years. You can often specify that the Trust will last for a term of ten years with several optional renewal periods.

Another way to use a Foreign Trust is to set it up and then transfer your cash, securities and other liquid portable assets to an account established under the name of the Trust at a bank of your choice in a foreign jurisdiction.

Many people are reluctant to transfer their assets out of the country or give up the day-to-day control of their investments unless it's absolutely necessary. To solve these concerns, planners combine the best elements of the Foreign Trust with the management and control of the limited partnership. Under this arrangement, you and your spouse are the general partners with total management and control over the partnership assets. But instead of you and your spouse holding a limited partnership share, you transfer that interest to a Trust in a favorable foreign jurisdiction.

As the holder of the limited partnership interest, the foreign Trustee has no right to interfere with management of the partnership. You alone manage your finances. Even though the Trustee holds the limited partnership certificate, the assets themselves are physically located in the United States. This set-up provides maximum flexibility and sound lawsuit protection.

The following is a brief summary of tools available for asset protection:

- The Children's Trust
- The Irrevocable Life Insurance Trust
- Family Limited Partnership
- Foreign Asset Protection Trust .
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