By Randy Fox
Founding Principle, InKnowVision, LLC

Many high net worth individuals don't usually consider "asset protection" a key issue. Yet for wealth creators and wealth holders, asset protection is vitally important. With an estimated 15 million lawsuits filed annually (that's 41,000 per day) in the United States, those who build wealth owe it to themselves to protect it. Some asset protection can be accomplished by simply acquiring the appropriate insurance. Additionally, state law generally provides some minimal protection. The question, though, is this enough? If a catastrophic event occurs, will what you currently have in place through your property insurance and state exemptions be enough to protect your assets?

Successful asset protection, that is, preventing unwanted creditors from getting to your wealth, requires careful planning. How you own what you own and where you own it are necessary considerations in a good asset protection plan. This planning requires a coordinated effort from multiple advisors: attorney, accountant, financial professional, insurance professional and others may be part of the process. Asset protection should not intend to avoid legitimate claims, nor is it intended to hide money or evade taxes. The purpose of a good asset protection plan is to protect your wealth from unwarranted claims of predators and creditors and to keep a nest egg amount of money safe if your financial world blows up.

Here is an example of how this might happen. Recently, a business owner's son borrowed his dad's car to go out on a Saturday night. Dad's car was owned by the family business. On the way home, the son was in a head on collision and was seriously injured. The passengers in the other vehicle were seriously injured as well. Unfortunately, the son was legally drunk and was clearly at fault. These circumstances, which are all too common, exposed all of the family's personal assets as well as the family business assets to the law suit that followed.

Insurance and state law exemptions will never be enough to cover the losses in such a situation. While the family is very aware of its responsibility, they are also now aware of the vulnerability of their assets. The family business may be lost or will have to borrow heavily to pay the impending judgment. A lifetime of work and perhaps a business that would have been passed to the next generation will never be the same. Jobs might be lost. What's more, the ripple effect of this unfortunate accident and the family's incomplete planning will impact many "other" victims.

Levels of Defense

There are many different approaches to asset protection. The first level of defense is good insurance. However, even good insurance is often not enough. You simply can't cover every eventuality. Next to consider is how you own what you own. Most people own their houses, investment accounts, businesses, autos, etc. in their own name or on joint tenancy with their spouses. There is no intervening entity between their assets and a lawsuit. Business owners are aware of the value of business entities. They form corporations or partnerships or limited liability companies own and operate their businesses. Even so, corporations offer little protection since the "corporate veil" is easily pierced.

Partnerships and limited liability companies are better since the regulations regarding an attack on these types of structures are relatively clear. Nonetheless, many business owners co-mingle risky assets. One entity often owns the operating business, the manufacturing plant and the delivery vehicles simply because it's less complex to do it this way. However, it also lumps all of the risks together and exposes all of the assets to all of the risks.

A better structure would be to have separate entities own the manufacturing plant, the operating business and the delivery trucks so that should one of the trucks be in a serious accident, only that portion of the business, not the entire business would be at risk.

The next level of protection is a consideration of "where" to own assets. Several of the states, Delaware, Alaska, Nevada and South Dakota for instance, have "asset protection statutes" on the books. These statutes allow someone to set up a trust for their own benefit ("a self-settled trust") that is protected from creditors under the laws of the state selected. While this type of planning is far better than most families have, there is still the risk that a federal jurisdiction will trump a state jurisdiction and overturn the domestic planning that someone has in place. The U. S. courts have a long reach. It would be difficult for any state authority to ignore the demands of a federal court to deliver assets because of a creditor judgment against someone who had established an asset protection trust in a particular state.

When "Going Offshore" May Make Sense

To get clear of the reach of the federal courts, it is necessary to consider international planning. Foreign jurisdictions are governed by their own governments and have their own rules which are different than U.S. rules. They simply don't have to respond to demands from U.S. courts. Many countries have instituted very strict laws that create strong asset protection because it's good for their economy to bring foreign business in. Nevis, the Cook Islands, The Isle of Man, Jersey and several others have specifically drafted legislation that is good for protecting assets.

The thought of going "offshore" with assets frankly frightens many Americans. It conjures images of suitcases full of cash and men with gold chains around their necks. However, foreign asset protection doesn't live up to the negative images. Business is done with established trust companies in tightly regulated environments. Many of these countries have been around as long as the United States and have well developed legislative histories. Still, skepticism toward utilizing a foreign jurisdiction to protect assets is likely a healthy thing.

One way to mitigate this fear is to only commit a small amount of assets to a foreign structure, call it a "nest egg" amount. This would be money that would be ultra safe so that in the event that all of your other protection mechanisms failed, there would be funds that were unassailable. Is this 10, 20 or 30% of your wealth? No one can answer that question but you. Another way to remove some of the fear in a foreign structure is to maintain as much control over the assets as possible at the same time without exposing them to your creditors. This can be done by creating the proper structures with an experienced asset protection advisor.

Case Study: Real Estate Crisis Takes its Toll

As an example, John, a successful developer, seems to have the Midas touch. All of his housing developments seemed to have been in the right place at the right time. The banks couldn't wait to lend him money and John didn't think twice about signing personal guarantees for the money he'd borrowed. However, John's attorney had been around during the last housing crunch and had watched one of his clients lose everything. He persuaded John to talk to a colleague who specialized in asset protection. John had accumulated a substantial amount of wealth and had been reinvesting it to grow his business. But he had also set aside about twenty percent of his assets or about $4 million in cash and stocks. John felt that if everything went bad (and he never thought it would), that he and his wife and children could start over with this amount of money. They could hang on until the housing market turned around.

With the help of the asset protection specialist, John and his wife set up an international asset protection plan. They transferred assets to an international Limited Liability Company (LLC) in which John had no ownership. Although this was somewhat unsettling for John, he understood that he could be the "manager" of the LLC and not the owner. Next he transferred the ownership of the LLC interests to an international Asset Protection Trust (APT). While John and his wife are beneficiaries of the APT, they really have no control over getting money from the trust. However, the proper checks and balances were put in place, so the funds were safe.

With the current housing and mortgage problems, John has been unable to pay his bank creditors. He signed personally and is currently struggling to repay all that he owes. But he is sleeping okay at night with the knowledge that his $4 million is there and unassailable if he needs it. John is a smart businessman and a great developer but he realizes he has no control over the economy. He will weather the storm because of good planning.

Final Thought

It is impractical and cumbersome to try to protect all of your assets. It is important, though, to consider protecting a portion of them. Certainly there are many approaches available and many issues to consider. It is extremely important to have a good team of advisors in place as well. There are tax and estate planning considerations that often accompany this type of planning and a tremendous amount of analysis should take place before you commit to moving forward. However, the result of a sound asset protection plan can be the difference between weathering an economic crisis or having to start over from scratch. The choice is yours.