Know whether or not your state exempts some, all, or none of the cash surrender value in your life policy, and if the state exempts the death benefit. If you live in a state where it is protected, funding a properly structured cash value life insurance policy as a wealth building will be a good way for many athletes to create a safe tax-free wealth building tool.
Annuities
Annuities are treated similarly to life insurance by each state when it comes to being treated as a protected asset. The main difference is that annuities are designed to pay out a stream of income at some point, whereas a lump sum death benefit is paid with a life insurance policy.
Some states will exempt all the cash built up in an annuity and the annuity stream, and some states will not protect either. Then there are the hybrid states which protect all of one and not the other, or some of each.
Florida, not surprisingly, exempts the cash in an annuity and the stream of income from any annuity. Pennsylvania generally permits the exemption of only $100 per month of the proceeds from an annuity, and North Carolina doesn’t exempt any proceeds that come from an annuity. Some states allow what is reasonably needed to live on as an exemption from an annuity.
Retirement Plans
In 1990, the United States Supreme Court made clear that a creditor (outside of bankruptcy) could not reach “ERISA qualified” plan assets. In 1992, the issue of whether an ERISA qualified plan was subject to bankruptcy was raised; and the answer from the Supreme Court was, “No.”
What is an ERISA qualified plan? Unfortunately, there is no definition of an ERISA qualified plan in the IRS code or under the Employment Retirement Income Security Act (ERISA). The Supreme Court did fashion its own definition and the factors to be considered are:
1) The plan must be subject to ERISA;
2) The plan must be qualified under Section 401 of the Internal Revenue Code;
3) The plan must contain the anti-alienation provisions which are required under both the IRC and ERISA.
Instead of explaining in detail what the above requirements mean, we instead will list the plans you will know that are ERISA qualified. In general, however, the plan must cover employees and cannot discriminate in favor of highly compensated employees.
1) 401(k) Plan
2) Profit Sharing Plan
3) Money Purchase Plan
4) New Comparability Plans
5) Defined Benefit Plan
6) 412(e)3 Defined Benefit Plan
Be sure to check with your pension plan provider (any listed above) to verify your plan is in compliance with ERISA laws. If your plan happens to fall out of compliance for whatever reason (and there are many plans that are not in technical compliance), then it will be left up to the courts and possibly the IRS to determine if your plan qualifies for exemption from creditors.
Non-ERISA Plans and IRAs. Simplified Employee Pension plans (SEPs) and Keogh plans are not specifically protected by federal law. The determination of whether SEP and Keogh plans are protected will be left up to each state to determine. If you have a SEP or Keogh plan that includes multiple employees and is funded in a non-discriminatory manner similar to ERISA governed plans, you will have a good argument for why those plans should be protected (especially in states like Florida and Texas, which have already exempted life insurance and annuities from creditors).
An IRA is not considered an ERISA qualified plan; and, therefore, the assets in an IRA have no federal protection from creditors.
Individual states, however, can and have protected IRAs in full (26 states) or in part. In states where IRAs are not specifically protected, it is up to the state courts to determine if, in a particular case, the IRA asset, in full or in part, is protected.
Recent Supreme Court Case. There has been a recent Supreme Court case addressing the issue of asset protection of IRAs in a “bankruptcy” case. The case changed the existing laws so that all IRAs are asset protected in a “bankruptcy” case. That sounds great, except 95% of the people who buy this book will not be in a position to file bankruptcy due to their amount of wealth. Therefore, it is my opinion that the recent Supreme Court case is of little good to those clients who live in states where the IRA is not fully protected by state law.
Solution. For those who have money in IRAs in states where they are not protected, the simple solution is to create a family limited partnership or limited liability company, name yourself a manager (which is an employee), start an ERISA protected profit sharing plan (PSP), and roll your IRA to the PSP. This will protect the assets in the IRA.
Typical Asset Protection Solutions (that do not always work)
Co-ownership comes in many forms, and most clients, and some attorneys and CPAs, believe that through co-ownership a client can adequately protect his/her assets.
Technically speaking, co-ownership can protect your assets. There are a number of problems associated with co-ownership that make its use not viable for many clients. There are many pros and cons with co-ownership that I do not have time to cover in this chapter.
Types of Co-ownership. There are three main types of co-ownership: Tenants in Common, Joint Tenants, and Tenants by the Entirety. Let me summarize the problems of each:
1) Joint Tenancy (JT)—A JT is the worst type of way to own property. With a JT, you typically own the property with one or more other people, but you all share a right to the “whole” property. This means that any one owner can leverage the property without consent of the other owners. What’s worse is that an interest in property owned as a JT is subject to the claims of your creditors (as it is with the other JTs and their creditors). This means that your interest in a property owned as JT with other JT owners is subject to their creditors. This is a disaster from an asset protection point of view.
Also, when you hear the term JT, you typically think of the term “with rights of survivorship.” Without getting too detailed, if you own a piece of property as JT with rights of survivorship, if you happen to die before the other joint owner(s), your heirs will receive NOTHING. That’s right. JT with rights of survivor is a gambling on life tenancy. Since most people want their interest in property to pass to their heirs, using a JT with rights of survivorship is not the tenancy you use.
Unfortunately, this is the most common way to own property. Be careful if you are working with advisors who recommend JT as a way to own property (because they know nothing about asset protection and will give you advice that is not in your best interest).
2) Tenants in Common (TIC)—TIC is virtually the same as owning property in a JT (meaning your ownership in the property is subject to your creditors and that of the creditors of the other owners). However, the good thing about owning property as a TIC with another owner is that your interest in the property can be passed to your heirs upon death (unlike a JT where you have to be the last person living in order to have the property pass to your heirs).
The bottom line with both JT and TIC is that neither should be used as a way to own property.
Corporate Entities
Most people think that great asset protection comes through the use of “corporations.” What most people do not realize is that there are different types of corporations and limited liability companies; and depending on which entity you chose, your asset protection and tax consequences could be different.
Sole Proprietorships. Sole proprietorships are the second worst way to own or run a business, behind a partnership.
Basically,