Maximize the Use of Exempt Assets
—Kevin B. Perlberg, CFP®, Susan S. Brousseau, CLU, ChFC, CFP®
Shrewd investors maximize the use of exempt assets in a portfolio. Exempt assets are those which cannot be claimed in a lawsuit. They include some or all of the primary residence (homestead protection varies, see below), life insurance proceeds, annuities, alimony, retirement accounts, and about $23,000 in personal property, among others. These types of assets carry significant asset-protection characteristics and are important to a well-protected portfolio.
Exempt Assets: Excellent Asset-Protection Tools
Exempt assets are considered to be great asset-protection tools because:
•There are generally minimal associated legal or accounting fees. Other financial tools have relatively high associated fees.
•There is generally no loss of ownership or control. By using exempt assets, you can own and access the asset at any time.
•The assets are well protected from creditors and litigation. Exempt assets generally enjoy the top (+5) protection up to their exempt amount. (See our article on the sliding scale of asset protection.)
Federally Exempt Assets
Federally exempt assets are those that are protected under Federal bankruptcy law. Federal law protects certain assets from creditors and lawsuits if the defendant is willing to file for bankruptcy. The two major asset classes protected by Federal law are qualified retirement plans (QRPs) and Individual Retirement Accounts (IRAs). Qualified Retirement Plans comply with Employee Retirement Income Security Act (ERISA) rules.
Individual retirement accounts are similar to qualified plans with a handful of technical differences. While the protection is maximal (+5), the debtor only receives this level of protection if he or she has filed for bankruptcy. In other cases, such as litigation outside of bankruptcy, asset protection may not apply.
If the debtor does not file for bankruptcy, the amount of value in the QRP or IRA that would be protected outside of bankruptcy would be governed by the applicable Federal and state laws.
In 1992, the U.S. Supreme Court, in Patterson v. Shumate, 504 U.S. 753, held that a participant’s interest in an ERISA-qualified pension plan was excluded from the participant’s bankruptcy estate and could not be used to satisfy the participant’s creditor claims.
Outside of bankruptcy, if a client’s retirement plan is an ERISA-qualified pension plan, creditors will generally not be able to access the asset. To understand the level of protection of QRPs and IRAs in your state, it is prudent to discuss the matter with your wealth management advisory team.