Over the last decade, too many business owners and professionals have sought cookie-cutter asset protection plans to give them some peace of mind that if they ever endure a lawsuit, they won’t lose everything. While we admire their commitment to pro-actively managing risk, we must remind them that all asset protection plans are not created equal. In fact, many will not even work if they ever are relied on.
Why is this? Essentially, it is because of a basic tenet of asset protection: that any asset protection plan that will truly stand up if challenged must have economic substance. Taken a step further, superior asset protection planning involves tools that are primarily used by people for non-asset protection purposes. In this way, the best asset protection plan involves tools typically not thought of as asset protection tools. In other words, the best asset protection is not asset protection.
Just Like Tax Planning
While few business owners and entrepreneurs realize this crucial fact of asset protection planning, all of the leading attorneys in the field know it quite well. In fact, we are not alone – as tax attorneys and CPAs know this adage is equally true when it comes to tax planning.
Simply put, when determining whether or not a particular transaction with significant tax benefits was an illegitimate tax shelter or not, the IRS or tax court typically uses a simple test – Would a taxpayer have done this deal if not for the tax benefit? In other words, they are asking whether or not this transaction was simply done to save taxes or did it have another economic purpose? If there was such a purpose, the transaction stands; if it was only tax-motivated, it fails.
This same test applies when evaluating whether or not a creditor protection tactic will be upheld if challenged down the road. Here, the question is did this transaction have an economic purpose… or was it simply done for asset protection purposes? If you are using tools that millions of Americans use daily for non-asset protection purposes, you can convincingly answer yes.
Asset Protection as a Sliding Scale
In the eleven books either of us have written, including Wealth Secrets of the Affluent, we use a sliding scale approach to evaluate asset protection techniques – with the lowest (-5) being an asset that is completely vulnerable and the highest (+5) being an asset that cannot be taken by a creditor even in bankruptcy. This is important to understand here because every (+5) asset protection technique, whether in a personal or business implementation, has significant economic benefits to the client, irrespective of asset protection.
Asset Protection which Isn’t
Which asset protection tools are not asset protection tools? Let’s examine a few of them briefly:
A. Qualified Retirement Plans: The term qualified retirement plan means that the retirement plan complies with certain Department of Labor and Internal Revenue Service rules. You might know such plans by their specific type, including pension plans, profit sharing plans, money purchase plans, 401(k)s, or 403(b)s. Properly structured plans offer a variety of real economic benefits: you can fully deduct contributions to these plans and funds within them grow tax-deferred. In fact, this is likely why most employers sponsor such a plan.
What you may not know is that under federal bankruptcy law, and nearly every state law, these plans are protected against lawsuits and creditor claims – enjoying (+5) protection status. IRAs are also (+5) protected in bankruptcy, with some limits, although their state protection depends on the state. For both, the overwhelming majority of millions of Americans who use qualified plans and IRAs are not using them for asset protection purposes. This, then, is a great example of attractive economic tools that just so happen to have tremendous asset protection benefits as well.
B. Non-Qualified Plans/Fringe Benefit Plans: Benefit plans that are not “qualified” are relatively unknown to business owners, despite the fact that they are right in the tax code and can be categorized as non-qualified plans or fringe benefit plans. These types of plans should be very attractive, as they can be terrific hedges against future tax increases and they can be used in addition to qualified plans. Once again, non-qualified/fringe benefit plans are generally not used for asset protection purposes, but for wealth accumulation/retirement, but they may have such benefits – depending on how they are structured.
C. Captive Insurance Companies (CICs): CICs are used by many of the Fortune 1000 companies, for a host of strategic reasons. In a small business setting, the owners create their own properly-licensed insurance company – to insure various types of business risks. These can be economic risks, business risks, litigation risks and even professional malpractice or product liability (keeping some risk in the captive and reinsuring the rest). If it is created and maintained properly, the CIC is like any insurance company — established in a real economic arrangement with its insureds. Also, CICs can enjoy tremendous creditor protection (+4/+5) if the ownership is structured properly.
D. Cash Value Life Insurance (CVLI): CVLI policies are purchased by millions of Americans each year for their tax benefits (generally, tax-free growth that may be accessed tax-free, and a death benefit paid income tax free to beneficiaries), for family protection and for estate planning purposes. Nonetheless, in many states, the cash value can enjoy the top (+5) protections. In this way, a client can purchase a product that is widely recognized as a part of a financial plan and enjoy (+5) protections easily.
Many who have implemented generic asset protection plans may be disappointed if they are ever attacked – as they may be ignored by courts that see no economic substance. On the other hand, those who implement techniques such as those described above may be pleased – not only will their protection be upheld, but they may build significant wealth along the way. The authors welcome your questions. You can contact them at (877) 656-4362 or through their website, www.ojmgroup.com
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David B. Mandell, JD, MBA and Jason M. O’Dell MS, CWM are principals of the financial consulting firm OJM Group (www.ojmgroup.com), which works collaboratively with professionals and their CPAs nationwide. David is a former practicing attorney and author of several books, including Wealth Secrets of the Affluent. Jason is an experienced entrepreneur, financial consultant and investment advisor and has worked with high-net worth families, business owner and physician clients for over 20 years. They can be reached at 877-656-4362 or firstname.lastname@example.org.