Like everything else in estate planning, asset protection isn't a one-size-fits-all proposition. What type of protection you need depends entirely on the type of asset you want to protect and the source of the potential threat - creditors, lawsuits, divorcing spouses, financial predators, remarriages, long-term care costs, income taxes, estate taxes, etc.
The unique combination of assets and threats directs us to specific strategies for protection.
Below are some of the most common tools used for certain types of protections; though, there are many others available to you. If you have questions about your potential liabilities and whether your assets may be exposed, we'd love to meet with you to discuss your options.
(This post will be longer than most, but we hope the detail shared is helpful.)
01/Revocable Living Trusts
Revocable Living Trusts provide the least amount of asset protection, but that doesn't mean there is none. At the most basic level, these trusts protect assets from the costs of guardianship and probate (so long as they are properly funded).
But do they offer any more protection? The answer is maybe. It depends on how the trust is drafted and funded.
Revocable Living Trusts do nothing to protect your assets from your valid creditors during your life time. BUT they may protect your assets after your death for the long-term benefit of your surviving spouse and your children.
What does that mean exactly? Well, here are two common scenarios in which a properly drafted Revocable Living Trust can provide some important asset protection:
A) One spouse dies before the other. Your surviving spouse is the beneficiary of the Revocable Living Trust. If the surviving spouse gets remarried, the trust can be protected from being comingled with the new spouse, which ensures it will be there for the benefit of your spouse and children, rather than a new spouse and children you've never met. Even if the surviving spouse never remarries, the trust can be protected from potential creditors down the road.
B) You and your spouse (if any) have both died. Your children are now the beneficiaries of the Revocable Living Trust. The trust can be protected from your children's divorcing spouses, creditors, and even from wasteful spending, if that is a concern. All the while, the trust remains available to pay for your children's education, healthcare, or even certain types of support.
If you have put a great deal of effort into funding "qualified retirement plans" (IRAs, 401ks, etc), then you understand the tax and growth benefits provided by these savings strategies. By saving in a qualified retirement plan, you can defer income taxes and limit, if not eliminate, capital gains taxes so long as you delay gratification and wait until certain ages to use the money you've worked so hard to save.
But how do those same benefits work once you've died and your children inherit those assets? Do the same rules apply to them?
Generally speaking, unless extra steps are taken, your children will be able to - and in some cases will be required to - deplete the retirement savings at a much faster pace than you may prefer. This means three things, primarily:
A) Big income tax hit for your beneficiaries.
B) No more tax-free growth on the principal (because it is depleted).
C) Asset exposure to your beneficiaries' liabilities.
One way that we are able to deal with all three of these problems, to greater and lesser degrees, is by using Retirement Trusts. These trusts can be revocable or irrevocable by you during your lifetime. While you are alive, they don't own any assets. Instead, they are named as the primary or contingent beneficiary of your retirement accounts (rather than naming your children or other beneficiaries individually).
The big picture is that these trusts can limit the income tax liability of your beneficiaries from year to year, allow for continued tax-free growth of principal, and protect inherited retirement money from your beneficiaries' liabilities.
There are MANY different types of Irrevocable Trusts - IDGTs, GRATs, GRUTs, DAPTs, ILITs, QPRTs, CRATs, CLATs, CRUTs, CLUTs, Medicaid/VA Qualification Trusts, and on and on and on...
Quite the alphabet soup, right? It's not important right now to distinguish between these different types of trusts. The critical point here is that transferring assets to an Irrevocable Trust is considered a more "complete gift" than a transfer to a revocable trust. In exchange for making that complete gift, those assets are protected from different types of liabilities - including taxes and creditors and long-term care costs - depending on how the trust is drafted.
Unlike the revocable trusts mentioned above, which can protect assets from your beneficiaries' liabilities, irrevocable trusts are designed to protect certain assets from YOUR liabilities.
So who uses these types of trusts? And do YOU need one?
A) Physicians or other professionals with potential malpractice or other lawsuit issues use these trusts to protect their homes or certain types of savings from loss in a lawsuit.
B) People with a net worth above the state and/or federal estate tax exemption amount use these types of trusts to "freeze" the value of their estates or to move certain assets out of their taxable estate altogether, helping them limit or eliminate their estate tax liability.
C) People who are anticipating long-term care in a nursing home use these trusts to remove certain assets from the Medicaid application process, or who are trying to qualify for certain Veterans benefits, such as Aid & Attendance, allowing them to qualify for benefits without first losing their home, family real estate, business interests, or certain types of savings.
04/Special Needs Trusts
A "special need" is any type of physical, mental, or developmental issue that qualifies someone for additional assistance from government benefits - income, rehab, housing, vocational training, healthcare, etc. Sometimes those benefits are offered no matter how few or how many assets a person has. But much of the time, those benefits are "means-tested." Meaning, not only must you have a special need, in medical terms, but you must also meet certain financial qualifications.
Special Needs Trusts (sometimes used interchangeably with "Supplemental Needs Trusts") are tools used to maximize the options for the person with the special need. What does that look like, or when might someone want to use a Special Needs Trust? Usually in one of the two following scenarios:
A) A person with a special need has a very limited amount of personal resources that will keep them from qualifying for government benefits, but will only provide a few years of care. This person will have to self-pay for all of their care until they are destitute, and without any additional resources to supplement (e.g. pay for a medication or treatment the government benefits won't cover) the government benefits. If that person has a Special Needs Trust, however, they have the option - not the requirement - to go ahead and qualify for the public benefits, and then use their own resources to supplement those benefits for a much longer period.
B) A child may have a special need that will require a lifetime of assistance. Grandparents, other family members, church members, and friends may wish to provide financial assistance to that care, but wisely want to avoid disqualifying the child from receiving necessary benefits either now or in the future. In such a case, those individuals could give to a Special Needs Trust for the child's benefit, ensuring that the child will always qualify for assistance and have plenty of additional resources to supplement their care.
These are two of the most common scenarios for creating a Special Needs Trust, but there are certainly many others. No matter the circumstance, the goal is to give the person with the special need as many resources and options as possible.
05/Family Limited Partnerships
The final tool we'll mention here is not a trust but, technically, a business entity. "Family Limited Partnerships" present opportunities for people to move certain assets out of their estates and into an entity that can benefit their entire family without giving up certain types of important control.
Family Limited Partnerships, or FLPs, allow people to limit or eliminate estate taxes, protect assets from their own creditors, protect assets for their surviving spouses or children and their creditors, and on and on and on.
FLPs are a flexible tool that can be used in conjunction with many of the other tools we've mentioned above - revocable and irrevocable trusts, special needs planning, etc. - and many that we've not mentioned here. They can be structured in a variety of ways, and they can own an enormous variety of types of assets, while still allowing you to maintain general management authority over those assets.
If you want to know more, we would love to talk with you about it. Best part, the conversation about how it could benefit you doesn't cost anything. Contact us at (918) 770-8940 or firstname.lastname@example.org to set up a free consultation, either in person, video chat, or phone call. Disclaimer: Reading this blog post does not create an attorney-client relationship, and it is not formal legal advice. This is for information purposes only. Your best bet, always, is to speak with an attorney about your questions, assets, concerns, and needs.