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.
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State Exempt Assets
State exemption leveraging should be a fundamental part of a financial plan. Some significant state exemptions are:
1.QRPs and IRAs;
2.Primary residence (or homestead);
Outside of bankruptcy, any protection for QRPs or IRAs is provided by state law. Most states provide +5 protection for QRPs. Fewer states shield IRAs at a +5 level. For IRAs, a number of states will only protect the amount reasonably necessary for support, leaving it up to a judge to decide how much should be shielded in any particular case. This is generally adequate for an investor who has not accumulated large amounts in such accounts. However, it may not be sufficient protection for investors with larger portfolios.
Primary Residence: Homestead
For most people, the home is their most valuable asset. While many states offer homestead protection in litigation, few states provide a total +5 shield for the home. (See our article on the sliding scale of asset protection.)
Most states protect between $10,000 and $60,000 of the homestead’s equity. Some states, such as New Jersey, provide no protection, while other states—Florida, Iowa, Kansas, and Texas—provide unlimited protection. In Arizona, the homestead protection is $150,000 and in Wisconsin it is $75,000. Given today’s real estate values and the equity that many investors have in their homes, it is clear that most states’ homestead exemptions provide inadequate protection.
To determine how well a homestead law protects your home, you should compare the protected value to the equity. In order to do so, subtract the value of any mortgages from the fair market value of your home. For example, if you live in a home with a $950,000 fair market value and have a $550,000 mortgage, then your equity is $400,000. If your state protects only $75,000 through its homestead law, as it does in Wisconsin, then you still have $325,000 ($400,000 of equity minus $75,000 homestead) of vulnerable equity.
Homestead protection is often automatic but in some cases may require additional action. Each state has specific requirements for claiming homestead status. In some states, you must file a declaration of homestead protection in a public office. Other states set a time requirement for residency before homestead protection is granted. Never assume your home is protected. Your wealth management team can show you how to comply with the formalities in your state.
All 50 states have laws protecting varying amounts of life insurance.
•Many states shield the entire policy proceeds from the creditors of the policyholder. Some also protect against the beneficiary’s creditors.
•States that do not protect the entire policy proceeds set amounts above which the creditor can take proceeds.
•Many states protect the policy proceeds only if the policy beneficiaries are the policyholder’s spouse, children, or other dependents.
•Some states protect a policy’s cash surrender value in addition to the policy proceeds. If you have substantial cash value in a life insurance policy, be sure to consult your wealth management team who will check the state exemptions and recent cases to determine how well protected you are.
•If the policy is purchased as part of a fraudulent transfer, a court can undo the policy. This is the same for any other fraudulent transfer.
Annuities: Shielded in Many States
Another exempt asset in many states is an annuity. An annuity is a contractual agreement between an insurance company and an investor. The investor gives money to the insurance company today in exchange for a potential return on the investment. The investor keeps the money with the insurance company over a long period of time and in return receives tax-deferred growth and strong protection of the principal on the sliding scale of asset protection. By using one of the various types of annuities an investor can vary the risk/return balance depending on his or her investing time horizon and risk tolerance. This diverse list of benefits makes annuities important components of asset protection and wealth accumulation plans.
We hope that it is clear to you that you should consider including exempt assets in a central manner with regards to your asset protection planning. Because the technical interplay among these assets can be exceedingly complex, it may be worth the time to consult with a multispecialty team that includes professionals who have experience with insurance products, tax, credit, QRPs, and asset-protection.
Kevin B. Perlberg, CFP®, is principal of Blackhawk Capital Partners. You can reach him at (480) 257-1604, or firstname.lastname@example.org.
Susan Brousseau CLU, ChFC, CFP®, is Senior Vice President and Wealth Advisor for Blackhawk Capital Partners. You can reach her at (480) 505-2011, or email@example.com.
Kevin B. Perlberg, Donald (Trace) W. Tendick, Tom Kueht and Christopher Nei are registered representatives offering securities through United Planners Financial Services, member FINRA, SIPC. Advisory services offered through Blackhawk Capital Partners. Susan Brousseau and Mike Miller offer Advisory Services Only. Blackhawk Capital Partners and United Planners Financial Services are independent companies.
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