Do You Need an Asset Protection Trust?
We’ve all heard about the lady who spilled hot coffee on herself and won a big judgment against McDonald’s. Or burglars suing their homeowner victims for injuries sustained while committing their crimes. Those stories, along with others making the news, are just the tip of the iceberg in the world of frivolous litigation.
Around 50,000 lawsuits are filed in the US every single day, many against hard-working Americans and business owners. Thanks to a legal system where plaintiffs – the party or parties filing claim – pay nothing unless they win a case, it often costs nothing to sue people. But those targeted could lose everything.
Worse, it could happen at any time – whether because of an unfounded sexual harassment case at work (unfortunately, these accusations are increasingly common), a car accident, a divorce, or your neighbor simply tripping on the steps outside your home.
So, should you call a lawyer right now to create an asset protection trust (APT)?
Probably not. Even if you think you need one, there’s a lot to consider beforehand.
Do This First…
The very first thing you need to do is make sure you have adequate liability insurance for your home and vehicles you own or lease.
Most homeowners/renter’s policies start with $100,000 of liability insurance, with options boosting this coverage to $300,000 or $500,000. However, I recommend minimum total liability coverage of $1 million. To do that, you’ll need to purchase an add-on policy called an excess liability, or umbrella, policy. Umbrella coverage is inexpensive since it kicks in only if you suffer a liability higher than the limits of your primary policy.
You might wonder why you need this much coverage, especially if you don’t have a lot of assets to protect. The reason is that it’s surprisingly easy for someone injured by your negligence to obtain a judgment against you.
However, liability insurance policies have a lot of holes in them. For instance, let’s say you host a party and serve alcohol. While driving home, one attendee runs over a pedestrian, killing him. The pedestrian’s family sues you and obtains a $2 million judgment. Unless you had the foresight to purchase “social host liability” insurance, you’ll be on the hook for the full $2 million. Even if you do, most policies limit the coverage to $300,000; often less.
Vehicle liability insurance coverage starts at around $100,000 for injuries to others that you cause. Again, I suggest boosting this coverage to $1 million with an umbrella policy.
Unfortunately, vehicle insurance policies also have many gaps. If someone not named on the policy drives the vehicle and has an accident, the damages may not be covered. And if you accept money to transport someone, even if you’re just splitting the cost of gas, you could void your coverage.
Multiply these exclusions by many others, and you can see why it’s important to set aside a protected nest egg that no one can grab if you lose a lawsuit. And if you operate a business, you face additional liability risks that even with business liability insurance in place could lead to your financial ruin.
Do This Next…
Another strategy you should review before you create an APT is to look for the asset protection opportunities you already have.
Most states have “homestead laws” which protect some portion of the equity you have in your personal residence. The limits are generally low and haven’t been raised in decades. But in a few states like Florida and Texas, the homestead exemption is unlimited. Paying down a mortgage is probably the best asset protection technique the “average Joe” should consider.
About 20 states allow you to hold title to property collectively with your spouse in an arrangement called “tenancy by the entireties.” Although there are exceptions, a judgment against one spouse generally won’t allow a forced division of the property.
The death benefits (and sometimes a portion or all its cash value) of life insurance policies and annuity contracts may be protected as well.
Enter the Trust (not an APT)
You’ll want to hire a lawyer to help advise you in these matters. The lawyer should also draft whatever trusts you need to set up, starting with a simple living trust, designed to avoid probate formalities – not for asset protection. But the trust can provide that assets inherited by a surviving spouse can be protected from their creditors.
The next trust to consider is a spendthrift discretionary trust. The term “spendthrift” refers to a trust that restricts the ability of a beneficiary from pledging trust assets to someone else. For instance, a beneficiary can’t use their interest in the trust for collateral on a loan. “Discretionary” refers to the ability of a trustee to withhold a distribution. A trustee could withhold a distribution to prevent a creditor of the beneficiary from seizing the funds, for example.
Let’s say you want to create a $100,000 nest egg for your children. You irrevocably convey assets worth $100,000 into a spendthrift discretionary trust for their benefit. Once you’ve done so, with very few exceptions, laws in effect in all 50 states stipulate that neither your creditors nor your children’s creditors can seize the assets. This type of trust is the gold standard for asset protection and is rarely challenged successfully.
Finally, the APT
Once you’ve done all this, but still think you need additional protection, you might want to consider an APT. This is a trust structured as a “self-settled spendthrift trust” (SSST). In this arrangement, the person funding the spendthrift trust is also a beneficiary.
SSSTs are controversial. Historically, there’s been a moral divide between someone creating a trust as a nest egg for their family verses that person seeking, in the words of one commentator, to “protect themselves against their own profligacy, at the expense of their creditors.”
In 1989, the Cook Islands became the first jurisdiction to stipulate that SSSTs would be protected. Despite being controversial, the law was an instant success, and hundreds of Cook Island international APTs were formed by wealthy Americans. Numerous other offshore jurisdictions, including the Bahamas, Belize, and Nevis, quickly enacted similar legislation. And many states began considering amending their own laws to stipulate SSSTs formed there would also enjoy asset protection. Today, 18 states have so-called “domestic asset protection trust” (DAPT) laws in effect.
DAPTs are much less expensive to create and administer than offshore APTs. But I’ve long been skeptical of DAPTs because I thought the courts of non-DAPT states would ignore the DAPT laws of states. Thus, if you get sued in a state other than the one in which you created a DAPT, the state where the lawsuit is filed in would likely apply its own law.
That’s exactly what’s happened a few times, but what’s struck me the most is how few challenges there have been to DAPTs. The fact that so few cases have even been brought demonstrates that creditors hesitate to challenge them. As a result, for the right client, I think a DAPT is worth considering.
If you’d like to learn more about DAPTs, I just completed a two-part analysis of them in the Nestmann Inner Circle Alert. I also just interviewed Steve Oshins, the inventor of a concept he calls a “hybrid DAPT” in the NIC quarterly interview, another benefit of NIC membership. To try a risk-free membership for yourself, click here.
Protecting your assets (and yourself) against any threat - from the government, the IRS or a frivolous lawsuit - is something The Nestmann Group has helped more than 15,000 Americans do over the last 30 years.
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