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Good estate planning often requires careful thought about asset protection. How can the client’s assets be shielded from lawsuits? How can the family’s wealth be protected from misuse by less responsible or less sophisticated family members? The selection of appropriate strategies must begin with a close examination of the details of the client’s family situation and balance sheet and a sensitive evaluation of the client’s comfort level with more aggressive approaches. Some form of trust is often the answer. But no strategy should be adopted that will be regretted if the potential problem never arises. Here we look at protecting assets from the client’s own creditors and from the creditors of children, grandchildren, parents, and surviving spouses. THE CLIENT AND HIS CREDITORS Do honest, conscientious people have any reason to worry about future creditors? Is it ever legitimate to undertake such planning, or is it always suggestive of fraud? Fair questions. The answer is that we live in a litigious society. The average American will be sued five times. Consider this scenari The owner of a closely held business agrees to sell his company to a larger, publicly traded company. But the seller is concerned that the new owner will not enjoy the financial results that it expects and will blame the seller. Perhaps the buyer does not fully understand the seller’s business, perhaps the seller anticipates adverse economic factors that the buyer does not, perhaps the buyer is simply not a good manager. The seller believes, human nature being what it is, that the buyer will seek a scapegoat — the seller. He is worried that the buyer will instruct his attorneys to develop a theory and sue to get some or all of his money back. How can the seller protect himself? A prudent client advised by a lawyer experienced in asset protection strategies would consider the following: Asset protection is best done early — if possible before the debt is entered into or the act triggering the liability occurs, but certainly as long as possible before the debt is in default or the liability matures. Frantic asset transfers after the liability is mature and apparent are clumsy at best, fraudulent at worst. Asset transfers are best defended from claims of fraud if they can be justified by some “business purpose” that has nothing to do with asset protection. Examples might be estate tax planning, income tax planning, financial planning, and probate avoidance. The protection strategy should document this purpose as the principal motivating force of the transaction. Certain assets may be retained by the nervous party, possibly with his spouse, without fear that they could be lost to future creditors. Examples are some types of retirement plan assets and property held as tenants by the entirety by a husband and wife (assuming that the potential claim is against only one spouse). It is frequently effective and more subtle to “uglify” an asset (i.e., make it unattractive to creditors) and retain it, rather than to convey it. In any case, subtlety and artfulness are desirable and rewarded. Greed and overreaching will be punished. More specifically, offshore trusts generally are not worth considering for sums less than $500,000. But for larger sums, a thoughtfully established offshore trust can be remarkably effective in frustrating creditor claims. The settlor of that trust may retain indirect control and be a beneficiary of the trust, even while his creditors are denied access to its funds. (Asset protection trusts established in certain U.S. states that promote them — Alaska, Delaware, Nevada, and Rhode Island — are not, in the author’s opinion, particularly effective.) Don’t rely on bankruptcy exemptions, which are generally narrow and becoming even narrower. Bankruptcy trustees are authorized and encouraged to examine for fraud transfers by the debtor within one year of the bankruptcy filing. Creditors on their own may challenge earlier transfers as fraudulent. Frequently, the best means to protect against unexpected liabilities is basic and umbrella liability insurance. Cash value life insurance placed in an irrevocable trust can be an excellent vehicle within which to accumulate funds for the family free of creditor claims. Last but not least, there is generally no strategy that will thwart the Internal Revenue Service. Pay your taxes. KIDS, GRANDKIDS, AND PARENTS To both protect assets from creditors and plan their estates, parents can make lifetime gifts to children and grandchildren through an irrevocable discretionary spendthrift trust. Such a trust will also preserve assets against indiscriminate use by the children and protect those assets from the children’s spouses and creditors. A discretionary spendthrift trust is particularly useful where there is a particular cause for concern — a child’s substance abuse, spendthrift habits, unpleasant spouse, or likelihood of being subject to lawsuits (e.g., the child is a physician) — or where the child is well off and does not need funds. The trust may last for the child’s life and then go automatically to the grandchildren. Beware that such a generation-skipping transfer requires very careful planning. Gifts for the benefit of children or grandchildren may also be made to Section 529 college savings plans and custodial accounts under the Uniform Transfers to Minors Act. The Section 529 plans are generally immune from claims by creditors of the donor or the beneficiary. The donor may retain control over these accounts and withdraw assets from them (at a penalty). If the named beneficiary does not need or use assets or otherwise turns out to be an inappropriate recipient of the family wealth, the donor may redesignate the plan balance for another family member. A first or second home can be transferred by the parents to a Qualified Personal Residence Trust, under which they retain the exclusive right to use the property for a fixed period of time, at the end of which the children irrevocably take title to it. The parents’ creditors will usually not be very interested in pursuing the parents’ limited interest in the home. Where parents want to provide a financial safety net for children or grandchildren with special needs without making them ineligible for state and federal benefit programs, the answer again may be an irrevocable discretionary spendthrift trust. At the death of the beneficiary, the remaining balance may be disposed to other family members or to charity. Ideally such a trust would also provide for the possibility of discretionary distributions to other beneficiaries, e.g., siblings of the disabled child. Multiple beneficiaries makes it less likely that a judge will invade and dissolve the trust to reimburse the state or federal government for benefit programs used by the disabled child. Where a client wants to provide a financial safety net for her own parents who may survive her, the parents can be made co-beneficiaries with the client’s spouse and children in a discretionary family trust. If the parents need funds, distributions may be made directly to a service provider — such as a landlord or a doctor — without putting into the parents’ hands assets that creditors or the government seeking reimbursement may attack or that may be subject to tax when the parents die. Finally, assets inherited by the client’s children should be kept in the children’s own names to protect from property settlement claims in a divorce. SPOUSES AND THEIR FAMILIES When it comes to providing for surviving spouses, yet ensuring that the family assets are eventually passed along to the client’s children, the answer is often a marital trust. The trust can be drafted to include (or not) children from either spouse’s previous marriage. If the surviving spouse remarries, the new spouse can be prevented from inheriting. Marital trusts are also useful where the spouse is a spendthrift, is infirm or incapacitated, or cannot or does not want the responsibility of managing inherited assets. The trustee chosen by the deceased spouse, not the beneficiary, manages the money. If the beneficiary spouse has creditors, they cannot get at the principal of the trust, although they can attach the beneficiary’s guaranteed income stream. Another means of protecting assets from a surviving spouse is a so-called family trust. A family trust is typically a discretionary spendthrift trust established for the benefit of the surviving spouse and children, and possibly grandchildren, of the deceased spouse. The trustee selected by the person who created the trust manages the assets, deciding whether and to whom to distribute income or principal. All of this constitutes just a short course in protecting assets. Each client’s individual situation must be carefully studied before any recommendations are made. Remember that a lawyer may be subject to ethical charges, malpractice claims, or fraud liability for assisting clients inappropriately, but may also face negligence claims for failure to suggest prudent prophylactic measures. Frederick J. Tansill is an estate planning attorney in McLean, Va. He has chaired the board of governors of the Virginia State Bar’s Trusts and Estates Section, co-chaired the D.C. Bar’s Estates, Trusts and Probate Law Section, and served as president of the Northern Virginia Estate Planning Council. Tansill is a fellow in the American College of Trust and Estate Counsel. He can be reached at [email protected].

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