Protecting what you already have is an important, and often overlooked, aspect of building wealth. It’s an unfortunate truth that we live in a litigious society and the target on your back only grows as you earn more wealth and status. That’s why practicing stealth wealth is one of the best strategies around!
Let’s take a look at just a few incidents that could put a serious dent in your wealth. Some of these are only relevant for business owners. Most can befall everyone. And some are especially relevant for higher-income earning professionals.
- Breach of Contract
- Vehicular Accidents
- Sexual Harassment Claims
- Employment Discrimination
- Professional Malpractice (medical or otherwise)
- Medical Bills
- Social Host Liability (e.g. serving alcohol to someone who subsequently drives drunk and causes an accident)
I could go on, but you probably get the point. Anyone with money is a target for those without and it’s up to you to protect yourself. Even asset protection strategies can only get you so far. Remember that while current assets can be protected, there is always the possibility that future income can be garnished. Unfortunately, there’s nothing that can be done to protect that.
As a side note, it’s also important to mention that although related, asset protection is a separate process from estate planning. While estate planning focuses on minimizing taxes and easing the transfer of wealth to future generations, asset protection focuses both on structures that would benefit estate planning and those that only matter when you’re alive. While there is some overlap, much of what you can do for asset protection does little for estate planning.
With that, let’s dig into how we can protect ourselves from the worst that creditors and lawyers can do to you.
How to Protect Assets
First and foremost, the best way to protect yourself is to practice stealth wealth and to not do anything really stupid. Accidents happen, so sometimes you can’t avoid something that puts your assets at risk. You can, however, limit the likelihood of those accidents happening. Don’t drink too much at a party or serve anyone too much at your party. Keep your sidewalks clean. If you have to have a dog, get a smart breed that is good with people and take basic precautions in keeping it away from kids and strangers.
Further, you can always practice stealth wealth, regardless of your circumstances. There are plenty of articles around the web on stealth wealth, but the major takeaway is to live your life at a lower visible wealth level. Don’t drive fancy cars, give your home address to as few people as possible, and never tell people how much you make or how much money you have. Even your profession can give it away. Instead of saying I work in investments, I simply share where I work (a local non-profit). If the person presses, I say either that I’m a manager or that I work in the finance department. Most people hear finance department and assume mid-level accountant, which is fine by me. I’ve even been mistaken for an insurance salesman! Once you get to know someone, then you can begin to divulge more.
You’ll also need to take steps to protect your assets before something happens. Waiting until you’re older or have more money won’t save you from that random lawsuit tomorrow. Plus, many of the concepts below require very little work or legal costs. Most can be done without the help of a lawyer. Once you get sued or a creditor takes action, you’re pretty much screwed. There are laws around fraudulent transfers where a judge can undo your transfer into a Trust or LLC or to your spouse. Not only that, but if deemed fraudulent, you will also have to pay the creditor’s legal fees and lose any goodwill you may have with the court.
Beyond the basics, let’s take a look at some specific ways to protect yourself.
- Insurance: Insurance is your first line of defense in protecting assets. Insurance premiums are something you pay every year but never want to use. However, you’ll be incredibly thankful that you did pay those premiums if something happens and insurance needs to step in. Given that they can help mitigate the worst financial crisis in our lives, we should all be happy to pay (to a point!).
- Homeowner’s Insurance: Someone slipping on your icy sidewalk and your dog biting the neighbor kid are just two examples of where a homeowner’s insurance policy would step in. For this article, let’s focus only on the liability portion of your homeowner’s policy. Most people have $300,000 or $500,000 in liability coverage on their homeowner’s policy. However, once you gain substantial wealth, that amount may not be enough. Increasing the liability coverage to $1 million is incredibly affordable, costing only a few more bucks annually. Going from $500,000 to $1 million cost me an extra $15 per year. That’s an excellent trade.
- Auto Insurance: Auto insurance is similar to homeowner’s on the liability front, except that it’s more expensive to increase the limit than homeowner’s. Depending on your driving habits, this may still be a worthwhile tradeoff. It’s often cheaper to increase your liability coverage here before getting an umbrella policy. There are two important notes to be careful with on auto insurance. First, ensure that you know what an excluded driver is and isn’t according to your policy. Your driving-age children may be excluded unless you take action and add them to your policy. If they are excluded and get into an accident, you aren’t covered. The second only applies if you are a business owner: Be careful with business use exclusions. If you are found to be doing something for your business with your personal vehicle and cause an accident, you may not be covered either.
- Umbrella Policy: An umbrella policy covers any liability above your liability coverages from other policies, up to whatever amount you buy. It also covers those random liability events that aren’t covered by other policies (libel, slander, mental anguish, etc.). Because it generally only gets used if you go through your liability coverage in your auto or homeowner’s policy or in exceedingly rare events, umbrella policies are quite cheap. You can often buy $1 million in umbrella liability insurance for a few hundred dollars or less per year. That’s also an excellent trade.
- Commercial Liability and Worker’s Comp Insurance: If you are a business owner, getting insurance related to your business is a must. If you have employees, worker’s compensation insurance can prevent you from losing your business if an employee gets hurt on the job (plus it’s required in most states).
- Separate Entities: The use of trusts, LLCs, and partnerships can all shield you personally from liabilities, if done correctly. Here is where a lawyer can be useful. For example, in order for a trust to be effective, it must be an irrevocable trust. Assets in revocable trusts can still be at risk since the courts do not view these assets as being legally separate. An irrevocable trust, on the other hand, has to get a government identification number and file taxes every year. It’s a lot of work, but you can gift assets each year to the trust to avoid the gift tax and shelter a significant amount of assets over time. Since the trust officially owns the assets without you having any ability to take them back, they are completely excluded from a lawsuit and you can still retain control.
Using separate entities works because it allows you to “own” fewer assets even though you still control them. The most effective place to use these is in your business and investing life. Your business should always be in an LLC or corporate structure, never a sole proprietorship or a partnership. Sole props have no personal liability limitations. Partnerships are even worse, with a general partnership leaving you open to lawsuits due to your partner’s mistakes! LLCs and corporations limit your losses to just what you have invested in them. Both your private businesses and private investments where you have a higher likelihood of getting sued, such as owning rental real estate, should be done through these structures.
- Retirement Accounts: Retirement accounts are protected from general creditors and lawsuits at both the federal and state level. On the federal level, employer-based plans (401k or 403b) are protected for an unlimited amount. IRAs are a bit different, with the limit being capped at a still substantial ~$1.3 million threshold (it’s inflation adjusted, so increases each year). The only limit here is contribution limits putting money into these accounts, which is what dampens the effectiveness somewhat. Unfortunately, you are not allowed to randomly contribute $100,000 one year because you want to protect your assets!
- Annuities and Life Insurance: Much like retirement accounts, both annuities and life insurance are protected from creditors. I won’t discuss the investment merits here, where the negatives far outweigh the positives. The only annuity that I would even consider is a single-premium immediate annuity with an inflation rider (in retirement age), and I would never consider whole life insurance. Nonetheless, both of these products are protected under most state laws. Check with your state to see what level of protection you get before considering, and always remember that the asset protection aspect of these products is likely not enough to outweigh the negative investment attributes.
- Use a HELOC: Having a HELOC or a mortgage on a home technically does not protect your assets from creditors or a lawsuit. It does, however, make you look less rich than you may actually be. Remember that lawsuits, especially frivolous ones, generally only go after people who actually have money. A bank that has either issued you a mortgage or given you a HELOC will place a lien on your property. Liens are public record, so someone digging for assets on you will see a mortgaged home. That makes you a poor target for a lawsuit.
Again, this relates only to appearances. The homestead exemption will protect your primary home in the event of a lawsuit, but because your home, even a fully paid off one, has a lien on it, lawyers may not find you an interesting enough target. Only rich people have paid off homes! Doing this helps you practice stealth wealth.
- Titling of Assets: The simple titling of your assets can have a surprisingly large effect on a lawsuit. Most lawsuits happen against a single person, so by titling assets in a way that the less at-risk spouse holds most of the assets, you can insulate yourself from lawsuits. Also, by titling your home or vacation home in a “joint tenancy in entirety” with your spouse, you have made it such that both of you own the whole thing and a creditor can’t force you to sell your share if you (and just you) get sued and lose. If you own a car, you can theoretically title it in just one spouse’s name. If you title the car in your wife’s name and you get sued, they can’t take the car. This can be done with any asset that has a title associated with it.
- Be Especially Cautious of Dangerous Assets: Finally, realize that some assets are inherently more at risk of lawsuits. Rental properties and business interests, as discussed above, should always be off of your personal balance sheet and into an LLC or corporate structure. Recreational vehicles, such as boats, ATVs, and snowmobiles, are notoriously dangerous and accident-prone. Either have an LLC own them and lease them personally, or ensure that they are well insured with additional umbrella coverage on top. The best way to avoid this risk is just not to own these vehicles, but they are awfully fun!
Don’t Be Stupid but Don’t Live Scared Either
Let’s be honest – most of us will live our entire life without getting sued in a major way or having creditors come after us. We can’t live our lives scared of losing everything. Nonetheless, people with money are much bigger targets than those without. My sister-in-law was recently in an accident and was injured (nothing too major). She wanted to sue, but soon realized that the other driver was not only broke, but was an uninsured motorist to boot! Needless to say, there was no legal action taken. Had that individual been driving a Mercedes and had a multi-million dollar balance sheet, you better believe there would have been a lawsuit.
Asset protection does not have to be complicated and rarely requires the need for a lawyer. Having proper insurance and maxing out retirement accounts are easy steps everyone should take. Utilizing trusts, LLCs, and corporations for your business ventures and private investments will protect you from personal liability. Even titling your assets or splitting assets between spouses can be beneficial. Asset protection doesn’t have to be difficult, but you do have to do it up front. Once you get sued, it’s too late.
Keep building my friends.