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Are Your Assets Adequately Protected?

Successful asset protection plans require foresight!

By the time a creditor is knocking at your client’s door, it is most likely too late to protect your client’s assets without risking stiff penalties for fraudulent conveyance.
All is not lost. First, clients need to understand what assets can be attached. For example, Maryland exempts from most creditors’ claims your clients’ retirement plans, such as IRAs, 401(k)’s, and 403(b)’s. Further, in Maryland, married clients may use titling property as tenants by the entirety to protect their joint assets from creditors of individual spouses; such ownership is possible for real property (such as the client’s home), bank accounts and brokerage accounts, among other things.

More sophisticated tools include irrevocable and asset protection trusts. Using corporate tools, such as LLC’s and certain types of partnerships, can also provide some measure of protection.
Your clients should be cautioned, however, because if they were to transfer title to assets for the purpose of protecting that property from creditors who were known at the time of any transfer, the creditor could claim that the transfer was a “fraudulent conveyance” and have a court disregard the transfer. For example, if a client is anticipating a lawsuit over a negligence claim, if that client transfers all of his assets into joint name with his or her spouse, those transfers could be considered fraudulent transfers.

Asset protection trusts have become quite popular in recent years. They are irrevocable trusts that can be used to protect a person’s assets from his or her own creditors. Although this approach sounds great in concept, the details can be problematic for many clients.

Here’s how an asset protection trust works. First, one must establish a properly drafted irrevocable trust in a state that authorizes such trusts. Maryland does not. However, many other states do, such as Delaware, Alaska, Tennessee, Missouri, South Dakota, Nevada and Utah. As part of drafting the trust agreement, typically state law will require that there be an “in-state trustee.” Trust departments in Banks can often fill this role under the trust agreement.

Now comes the more difficult part. In order to make this work, the person making the trust has to transfer assets into trust, and then turn over control of those assets to the trustee. In other words, the client will still retain the benefit of the assets, but will no longer control how assets those assets will be managed. Furthermore, most states require a waiting period, typically four years, before the asset protection features take effect. These can be tough for many clients to swallow.

The trust agreement can otherwise be like any other estate planning tool in the client’s tool box. The agreement can direct how the assets should be distributed upon the client’s death, including continuing the trust for minor beneficiaries or disabled beneficiaries. Note, also, that the assets in the trust will be included in the client’s taxable estate for Federal or Maryland Estate Tax purposes since any such trust would be considered a “grantor trust” under applicable IRS regulations.

Timing is very important. If a client has a pending court action, or even a threatened court action pending, any transfers to this type of trust could be considered a fraudulent transfer if the client is unable to pay any judgment with other resources. If bankruptcy is possible at the time the trust is established, the trustee in bankruptcy can disregard the trust and go after the assets in the trust. And, if a client wishes to use such a trust to avoid paying alimony or child support, most state laws will allow invasion of the trust to make these payments. Because of the 4-year waiting period, most of these cautions will not be a problem, but in some cases where they do apply, caution should be taken in determining that as asset protection trust should be implemented.

There is an additional risk that a client may need to consider. If the trust has a co-trustee who is located in a state other than the state that offers the creditor protection, or if trust assets are located in such another state, then if a judgment is rendered against the trustee or against the assets in the other state, a court in the state where the asset protection trust was set up may have no choice but to enforce that judgment and declare the entire transfer to the trust invalid. Thus, the choice of trustee and the selection of assets that will be used to fund the trust is critical for successful asset protection.

Since clients cannot protect assets to which a creditor already has a claim or a potential claim, an asset protection trust is most suitable for the client who is willing to give up direct control over part of his or her assets in return for creditor protection that may or may not become important concern in the future. Physicians or others in high risk businesses may find this planning tool quite attractive for this purpose.

When we have the right client who wishes to take advantage of the benefits of an asset protection trust, we can set up a such a trust as part of the client’s overall estate plan. The choice of jurisdiction for the trust depends on the client’s circumstances and the client’s choice of trustee. We have contacts with corporate trustees in various states that allow these trusts, but the client may have a trusted contact willing to serve as trustee or trust protector instead.