Financial Literacy & Independence for Teens - Step 9 - Asset Protection
KEY POINTS
Discover how to fortify your financial foundation with this guide on asset protection.
Delve into the world of legal strategies, investment insights, and insurance safeguards that shield your hard-earned wealth from unforeseen threats.
From preserving your principal residence to safeguarding your identity, this comprehensive resource equips you with the tools to secure your financial future.
Preserve and Protect
While you may have made prudent choices when it comes to education, career, and managing your finances, there's still one crucial aspect to consider – an integrated asset protection strategy.
Your journey towards financial success and literacy remains incomplete without developing and implementing this vital safeguard.
Now, before you start yawning, picture this: you've worked hard, earned some money, and maybe even saved up for that dream car or a down payment on a house. But have you ever wondered what happens if unexpected financial challenges come your way?
Can creditors take your assets?
Could a lawsuit bring financial ruin?
Will you be proactive or reactive?
That's where asset protection comes into play, and it's not just for adults!
Whether you're just starting your part-time job, established a full-time job in your chosen career, or venturing into entrepreneurial endeavors, understanding asset protection can be your secret weapon to safeguarding what's rightfully yours.
Let’s explore the key components of asset protection and learn how to control your financial destiny!
1. Tax Planning
Tax planning and asset protection often go together.
By leveraging the intricacies of tax laws and regulations, individuals and businesses can minimize their tax burdens while establishing effective layers of asset protection. This synergy between tax planning and asset protection often requires the guidance of professional advisors.
As detailed below, the legal structure and type of investment account can provide varying degrees of asset protection. Each type of legal entity and investment account will have its own unique tax profile.
2. Legal and Ownership Structuring
Legal and ownership structuring encompasses designing an ownership framework that maximizes asset protection while providing a foundation to support short-term and long-term financial goals.
A holistic and integrated design will ensure that an efficient structure emerges that can navigate the complex financial landscape including liquidity maintenance, cash management, investment management, taxation, and more.
The legal and tax aspects of the following structures vary by jurisdiction. We recommend engaging legal counsel and financial professionals when considering the implementation of any of the following.
Limited Liability
Limited liability is a legal concept that protects business owners by ensuring their personal assets remain separate and shielded from the liabilities incurred by the business.
This means that in the event of financial difficulties or lawsuits faced by the business, the owner's personal assets, such as their home or savings, are generally not at risk beyond their initial investment in the business.
The following common types of legal entities provide varying degrees of asset protection.
Sole Proprietorship
A business venture that is not formally registered as any other kind of business (e.g., partnership, corporation) is considered a sole proprietorship. It is an informal option, and it is easy to establish.
The business assets and liabilities are not legally separate from an individual’s personal assets and liabilities. Therefore, an individual can be held personally liable for the debts and obligations of the business.
Partnership
A partnership consists of two or more individuals that own a business together. Each partner contributes money, property, labor, skill, and expertise in exchange for a share of the profits generated by the business.
There are three primary types of partnerships: limited partnerships (“LP”), limited liability partnerships (“LLP”), and general partnerships (“GP”). Your degree of personal liability risk is dependent upon what kind of partner you are.
LPs consist of one general partner and multiple limited partners. The general partner manages the LP and has unlimited liability. The limited partners have minimal control of the LP and have limited liability up to the value of their respective investments in the LP.
LLPs consist of multiple limited partners. Each partner has limited liability against the debts and obligations of the LLP as well as actions of the other limited partners. The LLP structure is often utilized for professional services companies (e.g., law firm, accounting firm).
GPs consist of multiple partners that share in the operations, profits, and liability of the GP.
Corporation
The legal formation of a corporation involves many steps including the issuance of shares and the appointment of directors and officers. When starting a new business, the founding shareholders often assume roles as directors and officers.
Shareholders have a higher level of protection from legal liability as the corporation is a separate legal entity from its owners. Directors and officers are generally protected from personal liability. Directors and Officers liability insurance can be purchased to protect the individuals from personal loss if they are sued in connection with serving as a director or officer of the corporation.
Trusts
A trust is a legal arrangement where someone (the “Settlor”) transfers assets (e.g., money, investments, real estate) to the trust, to be managed by someone else (the “Trustee”), for the benefit of someone or something (the “Beneficiary”). A trust can have multiple beneficiaries.
The Settlor establishes the rules the Trustee must follow and imbeds such rules into the Declaration of Trust document upon establishment of the trust.
Trusts provide asset protection because once the assets are transferred into the trust, they no longer form part of the Settlor’s personal estate. Such a change in legal ownership can provide the following benefits, depending on the nature of the trust,
Creditors
Generally, creditors cannot access the assets of a trust to satisfy the Settlor’s debts. Such protects the trust’s assets from being seized or liquidated.
Lawsuits
Trusts may provide protection against potential lawsuits and claims.
Divorce
If a trust is set up as an irrevocable trust prior to marriage, the assets of the trust may be considered separate property and not subject to division in the divorce settlement.
Probate Avoidance
Probate is the legal process of distributing a deceased’s assets. Trusts often bypass the probate process as the assets are owned by the Trust and not the deceased. Therefore, the assets can be efficiently transferred directly to the Trust’s beneficiaries.
Estate Tax
Some trusts (e.g., certain insurance trusts) may provide an opportunity to minimize estate taxes.
Wills
Wills do not provide direct asset protection. However, they can provide indirect asset protection when properly executed.
A will is a legal document that outlines how a person’s assets and property should be distributed after death. It provides a set of instructions to ensure the deceased’s wishes are carried out, while designating the beneficiaries that will inherit the assets.
The following provide indirect ways to use a will to increase your estate’s overall level of asset protection.
Trusts
As noted above, an individual can establish a formal trust and designate its beneficiaries. The individual’s will could then appoint the trust as a beneficiary.
Upon death, the individual’s assets would be transferred to the trust, where they would be asset protected and distributed to the trust’s beneficiaries in accordance with the Declaration of Trust.
Choose Your Executor Wisely
You will appoint an executor when formalizing a will. An executor manages the estate after death and ensures the wishes documented in the will are carried out.
It is critical that a trustworthy individual is designated as the executor to ensure the assets are protected during the probate process.
Gifts
By transferring assets through mechanisms like trusts (e.g., family trust, irrevocable trust) and gifting strategies, individuals can ensure their assets remain within the family's control and protected from external threats.
These strategies are complex from a legal perspective and may trigger clawback provisions, fraudulent transfer laws, and other legal considerations.
3. Investments
Asset protection can be derived from investment decisions and tax planning. Such processes may integrate the legal structures and insurance products described above.
Nature of Account
The extent to which your investments are protected, if at all, will differ depending on the type of account in which they are held.
Investment Accounts
These accounts are standard taxable brokerage accounts that can hold and trade stocks, bonds, mutual funds, options, exchange traded funds, and more. These accounts do not typically provide any asset protection.
Retirement Accounts
These accounts are specifically designed to encourage individuals to save for retirement and provide them with a means to do so. These accounts often come with varying degrees of legal protection from creditors and lawsuits.
Tax-Deferred Accounts
These accounts are a subset of retirement accounts noted above. The earnings within such accounts (e.g., capital gains, dividends, interest) grow tax-deferred until the date of withdrawal. These accounts often come with varying degrees of asset protection.
Account Considerations
The degree of asset protection offered by the above accounts will be influenced by factors including, but not restricted to, the following:
Jurisdiction
Every country, state, province, or territory has the authority to utilize its legislative capabilities to establish distinct asset protection laws for each account type.
Creditor Exemptions
Many jurisdictions have laws that specifically exempt certain retirement accounts from being seized by creditors. Such is designed to encourage individuals to save for retirement.
Rollovers and Contributions
Rolling assets from one account to another or making excessive contributions could have an adverse effect on the level of asset protection.
It is essential that individuals consult with a financial advisor or obtain legal advice to ensure a comprehensive understanding of the asset protection laws specific to their jurisdiction.
Asset Allocation and Diversification
Asset allocation is the process of allocating investments across assets classes that may include cash, stocks, bonds, real estate, hedge funds, and more. Diversification is the process of diversifying the holdings within each asset class across multiple securities within the respective asset class.
Asset allocation can reduce a portfolio’s risks associated with a single asset class. Diversification can reduce a portfolio’s risks associated with individual securities.
These strategies do not provide asset protection from creditors or lawsuits. Rather, they are strategies utilized to design a portfolio based on an individual’s unique goals, risk tolerance, and investment time horizon.
Ideally, the portfolio will provide downside protection from adverse market conditions that is in accordance with the individual’s risk tolerance.
Emergency Fund
An emergency fund becomes crucial in challenging economic situations such as job loss or unforeseen financial burdens. It offers immediate financial support while simultaneously easing anxiety. In its absence, individuals might have to liquidate assets or accumulate high-cost debt to cover necessary costs.
4. Insurance Based Protection
Insurance-based asset protection may be attainable through various insurance policies tailored to an individual’s specific needs, such as property, liability, or business interruption insurance. Such may mitigate financial losses that may arise from unexpected events like accidents, natural disasters, or lawsuits.
This method aims to create a safety net, shielding assets from potential creditors and legal claims, thereby preserving wealth, and ensuring financial stability.
The inclusion of insurance policies may require integrated planning involving asset protection, taxation, investments, and more. Individuals should consider engaging a professional advisor as the degree of complexity increases.
Below are examples of different types of insurance that offer varying degrees of asset protection.
Health Insurance
Health insurance provides asset protection by shielding individuals and families from the exorbitant costs of medical care.
In the event of unexpected illnesses or accidents, health insurance may cover a significant portion of medical expenses, preventing individuals from depleting their savings or liquidating assets to pay for treatment.
Homeowners Insurance
Homeownership has been a cornerstone of multi-generational wealth for many nations. Homeowners insurance provides critical asset protection for property owners by safeguarding this most valuable and cherished asset.
In the event of disasters such as fire, theft, vandalism, or natural calamities, homeowners insurance covers the cost of repairs or rebuilding, preventing the loss of the entire property's value.
In addition, the liability coverage within homeowners insurance shields assets from potential lawsuits arising from accidents that occur on the property, providing additional financial protection and peace of mind for homeowners.
Auto Insurance
Auto insurance provides asset protection by covering potential financial losses resulting from accidents, theft, or damage to the insured vehicle.
In the event of a collision, comprehensive or liability coverage can help pay for repairs or replacement, preventing significant out-of-pocket expenses and safeguarding the value of the vehicle.
Additionally, auto insurance often includes liability protection, which covers the costs of third-party injuries or property damage, shielding the policyholder's assets from potential lawsuits and legal claims.
Umbrella Insurance
Umbrella insurance provides asset protection by extending liability coverage beyond the limits of primary insurance policies, such as homeowners or auto insurance.
In the event of a catastrophic accident or lawsuit where the liability costs exceed the limits of the underlying policies, the umbrella insurance is triggered to cover the additional expenses, preventing the policyholder from depleting personal savings or selling assets to settle the claim.
Disability Insurance
Disability insurance ensures financial stability in the event of a disabling injury or illness that prevents an individual from working.
By providing a steady income replacement, disability insurance helps cover essential expenses, such as mortgage payments, utility bills, and daily living costs, without depleting personal savings or liquidating assets.
5. Principal Residence
A person's principal residence is frequently their most valuable possession and a fundamental element of their approach to building wealth. Therefore, we chose to highlight it separately.
Safeguarding this property is a widespread practice, albeit with notable differences among different legal jurisdictions. A degree of asset protection may be obtained in the subsequent ways:
Home Insurance
As described above, home insurance is an essential first step to protecting your home. Such is also mandatory if you utilize the home to secure any form of financing.
Titling
Legal title of property is a critical determining factor in the ability of a creditor to make a claim on the property. The following options may provide varying degrees of asset protection.
We recommend obtaining professional legal advice prior to implementing any of these strategies as they are complex in nature and their applicability will vary by jurisdiction.
Asset Protection Trust
As described above, assets that are transferred to a trust may enjoy enhanced levels of asset protection. Some jurisdictions offer asset protection trusts that are specifically designed for this purpose.
Limited Liability Company
Like the Asset Protection Trust option above, transferring the home to a limited liability company may shield it from personal liability.
Title vs. Ownership
It may be prudent to put the title of the property in the name of one spouse to protect it against potential creditors and lawsuits of the other spouse. For example, if one spouse owns their own company, it may be wise to have the other spouse hold the title to the property.
In some jurisdictions, both spouses would have a claim to the value of the house even though legal title is held by a single individual. This element may prove critical during future divorce proceedings.
Pre-Nuptial or Post-Nuptial
These agreements outline how property will be divided in the event of a divorce. Such can provide clarity on how a house or other property should be treated.
Legislation
Legislation at the federal, state / provincial, or municipal level may provide a degree of asset protection to individuals facing financial hardship and creditor claims. Such may include limiting the creditor’s ability to force the sale of a principal residence to satisfy debts or preventing the home from being sold to settle unsecured debts.
Homeowners can also make use of any protective measures offered by bankruptcy proceedings or insolvency laws.
Equity Stripping
Creditors may be less inclined to pursue a property that has a mortgage and equity line of credit equal to the value of the owner’s equity. The timing of such financial actions may impact the effectiveness of this strategy from a legal perspective. A professional advisor can provide critical advice as to the appropriateness of this strategy.
6. Privacy and Identity Protection
Identity protection is arguably the most important form of asset protection. Your identity is intricately tied to various aspects of your life including financial accounts, credit history, personal relationships, and more.
If your identity becomes compromised, criminals may gain direct access to your accounts. They may be able to make structural changes, transfer assets, liquidate assets, disburse assets, secure loans, abscond with the funds, and more.
A compromised identity can take several months to rectify. In the meantime, you could be left in debt with a ruined credit rating and reputation.
The following steps are aimed at minimizing your risk of being a victim of identity theft,
Limit Sharing Personal Information
Be careful not to share personal data on social media platforms (e.g., birthdate, anniversary, address, vacation plans).
Accessing Networks
Avoid using public networks when transmitting sensitive personal information unless you utilize a virtual private network.
Passwords
Create unique passwords for each account. The passwords should be complex. Ideally, two factor authentication should be utilized whenever possible.
Monitor Financial Statements
Regularly review your bank statements, credit card statements, and investment statements to identify unauthorized or suspicious transactions.
Monitor Credit Reports
Regularly review your credit report while looking for unauthorized accounts, unexpected account balances, changes in personal information, new credit inquiries, and more.
Shred Documents
Dispose of sensitive documents by shredding them as opposed to simply placing them in the trash.
BOTTOM LINE
While you may have made wise choices in education, career, and finances, the need to safeguard your assets from unforeseen financial challenges is paramount.
The degree of asset protection can be increased through a strategic integration of the key components highlighted: tax planning, legal and ownership structuring, investments, insurance-based protection, protection of principal residences, and privacy and identity protection.
We cannot overemphasize the significance of seeking professional advice and taking proactive steps to ensure financial security and preserve hard-earned assets. Whether through utilizing trusts, understanding legal entity types, considering insurance policies, or safeguarding one's identity.
