Covering Your Assets - How the Financial Pros Are Protecting Their Assets

During the past year of fi nancial turmoil, we have seen a clear refocusing of attention on strategies to minimize fi nancial and liability risks. The question that many are asking is “How do we protect our remaining savings and retirement nest egg from the risk of these liabilities?”

Lately, a particular technique known as a Delaware asset protection trust has been the focus of considerable attention. A recent article in the New York Times pointed out that the Delaware asset protection trust, once popular with physicians and business owners, is now favored by hedge fund managers, bankers, and others in the investment world for protecting substantial assets from government regulators and unhappy investors.

The fact that financial pros are protecting their assets may or may not be good news, depending on your point of view. Nevertheless, it’s always interesting to know what the so-called “smart money” is up to.

Many people want asset protection for their nest egg while continuing to use the income and maybe the principal to pay for their personal living expenses. For example, a retired client wants to protect his savings of $5 million from general lawsuit risks. The problem is that he needs the income to live on each year. These types of trusts are called “self-settled” trusts, and for centuries, English and American laws have held that an individual cannot protect savings from creditors with a trust while reserving a right to use the income and/or principal for his or her own benefit. This rule certainly makes sense (at least to creditors) and refl ects the dominant public policy that one should not be able to maintain full enjoyment of one’s property without meeting one’s legitimate obligations.

For those individuals who don’t need the income from their savings to live on because they have an independent source of income from a business or professional practice, there are many asset protection strategies that will be successful. Physicians who live on the income from their practice and not on the income from their savings are usually in a good position to implement these strategies. But for those without an independent source of income, until fairly recently, the only hope for asset protection was an offshore trust, organized under the laws of a country that legally sanctioned trusts for these asset protection purposes (http://tinyurl.com/yeh2oqm).

As these offshore trusts gained in popularity, some US states viewed the demand for these trusts as a ripe business opportunity to provide a lucrative fi nancial service for clients in a local setting without the uncertainty and inconvenience of foreign banking. About 10 years ago, Delaware and Alaska, and subsequently seven other states, adopted laws that essentially duplicated the rules in the offshore jurisdictions by creating a category of domestic asset protection trusts (DAPTs). Under these new laws, self-settled trusts were permitted. Asset protection could be accomplished even for trusts reserving to the settlor a right to the income or principal, if the appropriate rules are followed. The specifi cs of these laws differ from state to state, but generally DAPTs must have at least one independent trustee located in the state of choice, and any distributions to the settlor must be approved by that trustee.

Are these DAPTs effective for asset protection? There has been a surprising lack of case law on this issue, but it’s probably true that if you live in one of the states with these laws and keep your assets and the administration of the DAPT within that jurisdiction, then the legal asset protection should be strong. In the case of a bankruptcy, The Bankruptcy Reform Act of 2006 states that “Asset Protection Trusts” can be set aside by the Bankruptcy Trustee if formed within the previous 10 years with an actual intent to hinder, delay, or defraud a creditor. What constitutes such prohibited “intent” is a fairly large and debatable issue, but it seems likely that DAPTs created prior to the10-year period will be respected under federal bankruptcy law, even if formed with an “evil” intent. Further, for those living in other states and attempting to use a DAPT, we don’t yet know whether assets in these trusts can be protected from a legal judgment and a collection action in your home state.

Recommendations

We generally make the following recommendations to our clients:

1. If you need to live on the current income from your savings, a DAPT is useful if you live in a state with DAPT legislation. If you live in another state, its usefulness is less certain. For a bankruptcy, however, regardless of your home state, and especially if it is formed more than 10 years from the fi ling, the DAPT should be respected. The most solid foundation is a DAPT combined with an offshore asset protection trust to maximize the protective attributes.

2. If you have a secure source of income from a professional practice or business and wish to protect a retirement nest egg, the DAPT can be very successful for you. The drawbacks are that they are fairly expensive to maintain, and other less expensive, more fl exible strategies may work just as well.

As always, please consult your local attorney and tax advisor to discuss the effect of these strategies on your particular situation.

Robert J. Mintz, JD, is an attorney and the author of the book Asset Protection for Physicians and High-risk Business Owners. To receive a complimentary copy of the book, call 800-223-4291 or visit www.rjmintz.com. Have a question of your own you'd like to submit to ask Robert Mintz? Send an e-mail to ccole@mdng.com. Then leave a comment below.