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How to Protect Client Assets

Liquidity claims against professionals, business owners and wealthy individuals are rising. What can you do to help clients minimize risk of losses

Picture this: You're sitting down to lunch with an extremely successful prospect and you're hitting it off. He has amassed a net worth of millions and would make a valuable client. You think you've won him over and are already looking forward to managing his assets when he tells you that he's very afraid. He's afraid that he's one lawsuit away from losing some or all of what he has worked for his entire career. And he wants you to do something about it.

You, the advisor, need to be prepared for this, because ours is a litigious society. Anyone can be sued for anything at any time. And, for many successful professionals and business owners, it is just a matter of time. Some 6.5 percent of U.S. firms have experienced a loss of $5 million or more thanks to lawsuits, liabilities and settlements, according to the Insurance Information Institute. The average medical malpractice jury award now tops $4.7 million, according to Jury Verdict Research, and a 2005 survey of high-net-worth individuals by Registered Rep. and Prince Associates found that nearly six in 10 individuals with between $3 million and $10 million in net worth are afraid of being sued (See “You Say, They Say,” September 2005). Against these risks, homeowner and umbrella liability coverage are generally little more than fig leafs compared to the potential risk.

So what can an advisor do to protect his clients? You need to start by learning about asset-protection strategies that allow an individual to create legal barriers and disincentives to potential litigants, says Roccy DeFrancesco, a Michigan attorney who runs the Wealth Preservation Institute, which markets a training and certification program to advisors. Asset protection is perfectly legal and does not rely on “hiding assets” or defrauding creditors. And your clients may need it.

Who Needs Asset Protection?

  1. People with homes

    If your client hosts a party and someone slips or has too much to drink and gets in a wreck, he or she could be liable.

  2. People with businesses

    One workplace injury can endanger the business owner's family home.

  3. People with teenage children

    Teenagers drive, drink and hold parties when the folks are away. Guess who's liable in a lawsuit?

  4. Professionals

    Professionals are frequent targets for malpractice and negligence lawsuits.

A sharp and knowledgeable advisor can add significant value — and build the advisor-client bond — by understanding the basics of asset protection in three areas: the home, the business and the family.

Protecting the Home

State laws often protect your clients' home equity to some extent. That level varies widely, depending on the state. Texas and Florida make it easy: Both provide unlimited exemptions for home equity, subject to a 1,215 day look-back period in the case of bankruptcies — if you declare bankruptcy within 1,215 days of buying a homestead, the protected equity is limited to $125,000. Most states offer much more modest exemptions for home equity, and some states — New Jersey, Maryland, Pennsylvania and Rhode Island, for example — provide none. A federal bankruptcy exemption is still available, but you may wish to help your client explore some other techniques

  • Tenancy by the entirety

    Where home-equity protection is limited or where the federal bankruptcy law disallows homestead protection in your client's case, then the titling of the marital home comes into play. Some states allow a husband and wife to own their personal residence (not business properties) as “tenants by the entirety.” Under these rules, each spouse owns an undivided interest in the entire home, which means that a creditor of one spouse cannot force the other to sell his or her interest in the home to satisfy a judgment. Unfortunately, says DeFrancesco, this doesn't provide much protection for singles or in a judgment where both spouses are named as defendants.

  • Equity stripping

    By borrowing against his home and investing the proceeds in another protected or exempt asset, such as a cash-value life insurance policy or an annuity, your client can put any plaintiffs in a difficult position: If the plaintiff tries to take your client's home, he has to get in line behind the bank to collect.

  • Annuities

    Annuities often receive substantial protection from creditors, though again, this varies from state to state. Some states will even shelter the stream of payments up to a certain point. Even where annuity payments are exposed, creditors may be deterred from pursuing a judgment, since they can only access the stream of annuity payments rather than the lump sum. Further, the creditor is forced to assume the risk that your client may die prematurely — stanching the flow of payments. Rather than pursue a judgment, creditors may be inclined to settle on more favorable terms.

  • Life insurance

    Most states provide some shelter for life insurance proceeds, though specific measures vary widely. Some states shelter the entire death benefit, others only the cash value.

Both life insurance and annuities may be useful tools for converting nonprotected assets, such as home equity or accounts receivable, into protected assets. For example, a business owner with a good deal of accounts receivables could take out a loan against them and invest in a life insurance or annuity policy instead (provided that the state protects the policy from creditors).

Caution: There is some controversy surrounding the technique of factoring against accounts receivable. The technique is especially popular among doctors and the California Medical Association has endorsed the technique for all of its members. But does it work as intended?

“Total garbage,” dismisses DeFrancesco — who authored The Doctor's Wealth Preservation Guide — in a recent newsletter to asset-protection planners. The problem is threefold, DeFrancesco argues: First, accounts receivable are rarely considered in malpractice claims. Second, the interest on loans taken against accounts receivable is generally not tax-deductible. Third, except for in Texas, Florida and a few other states, the life insurance that marketers recommend as a vehicle for loan proceeds offers scant protection from creditors under state laws.

Protecting the Business

A good rule of thumb for asset-protection planning is to separate business and personal assets. Putting personal assets in a business entity can invalidate the legality of the entity, leaving the assets unprotected anyway. Plus, if your client tries to put his personal residence in a limited liability company (LLC), for example, he or she could also lose valuable tax benefits, such as the home mortgage interest deduction. And while S-corporations can help shield a doctor's personal assets from professional negligence on the part of his or her partners, they provide no protection from the professional's own negligence. Further, when a creditor gains ownership of shares in an S-corporation, the owner's privacy goes out the window. As part-owner in the corporation, the creditor has the right to pore through the books — which can create all manner of discovery nightmares.

The Beauty of COPEs

Certain kinds of corporations, like LLCs and limited partnerships (LPs), can shield a defendant's share of ownership in the company, limiting creditor access to profit distributions. These are called charging order protection entities (COPEs). Basically, if your client is a partner in a multi-owner corporation of this type, a creditor cannot force him to sell his share, because these corporations don't issue shares. The creditor can only claim a piece of all future distributions.

This is where the fun begins. Let's say the creditor decides to seek compensation from distributions. Provided your client is not the sole owner of the LLC, the creditor cannot force the LLC to make distributions against the client's will. And yet, the creditor will still be taxed as if he had received the distributions, based on the corporation's reported income. To say the least, this puts a bad taste in a creditor's mouth, makes it more difficult for him to find a lawyer who will take the case on contingency and creates a powerful incentive for the creditor to settle on favorable terms.

This charging order protection is not limited to LLCs or LPs; it also applies to limited liability partnerships (LLPs), limited liability limited partnerships (LLLPs) and series LLCs. The protection may not apply to single-member corporations.

COPEs are better at protecting against liability for other reasons. If the court transfers shares of an S-corporation to a corporate or overseas creditor, the whole S-corporation can be invalidated — with terrible tax implications for remaining shareholders.

Partnerships — The Worst of All Worlds

Most clients understand that personal assets are at risk when they do business as sole proprietorships. What is less frequently understood is that when someone forms a general partnership with others, his or her risk goes up exponentially with each additional partner. Say your client's partner takes the car to pick up a customer and gets into a wreck and can't cover the liabilities, the plaintiffs can come after your client's home — regardless of fault. “Never allow your clients to be in a partnership,” counsels DeFrancesco.

Business Assets

Clients who are worried about liability should lease, rather than own, expensive capital equipment. The more they lease, the less assets they have in their own name — and the more difficult any recovery will become. California attorney Jay Adkisson, co-author of Asset Protection: Concepts and Strategies for Protecting Your Wealth, has one solution: Suggest your client own a separate entity that leases equipment back to the liability-producing business. For example, a physician may own two LLCs — one that holds his practice and another that owns the equipment and the real estate.

Retirement Accounts

While 401(k)s and other ERISA-qualified plans have long received solid protection from creditors, until recently, protections afforded to IRAs were much more uncertain and varied by state. But a 2005 Supreme Court decision (Rousey v. Jacoway) makes it much more difficult for creditors to raid IRA accounts, depending on the extent to which those balances are necessary for your clients' support in retirement.

Protecting the Family


Current tax law allows for a $12,000 gifting exemption. That means a couple can give $24,000 to each child and another $24,000 to each child's spouse — and another $24,000 to each grandchild, each year, tax-free. That can enable your clients to protect up to $1 million each before the lifetime gifting limit applies.


Trusts can be effective, provided they are properly structured. From an asset-protection point of view, they should be irrevocable. “Revocable trusts are basically worthless from an asset-protection standpoint,” says Adkisson. Federal law requires that any self-settled trust must be at least 10 years older than any bankruptcy filing to provide any bankruptcy protection.

Offshore Planning

Opinions vary sharply on this controversial topic. On one hand, Adkisson warns his clients against the technique, pointing to a series of court cases in which courts threw defendants in jail for contempt when they refused to move assets back to the U.S. and within their jurisdiction. On the other hand, DeFrancesco points out that while U.S. courts have indeed thrown bad actors into prison, no foreign trust has ever been forcefully broken up by U.S. courts. Where the assets involved are enough to warrant the costs, foreign asset protection trusts are “absolutely the best way to protect assets,” he argues.

The key to making them work? Your clients need to give up any pretense of retaining control over the money — including the power to name and change trustees at will. The client can even name himself as beneficiary and receive a stream of payments from the trust — so long as he or she does not have control of the money, counsels Tanzer. A creditor could access that stream of payments, but probably not the principal in the offshore trust.

Asset protection and wealth preservation are specialized fields. A lot of heavily marketed measures that seem to work at first glance — such as Nevada corporations, Alaska trusts and Delaware trusts — wind up collapsing when they encounter the acid tests of the court system. Much of current asset-protection practice comes from case law — which requires time and effort to research and understand. Don't try to do this off the top of your head. Work with your client's CPA and attorney, or take the time to learn the field yourself.

Ten Stupid Things People Do to Risk Everything They Own

  1. Own everything in his or her own name

    John Fredricks doesn't have to own a company called John Fredricks, Inc. Why give people targets? If creditors can't find your assets, they may not bother with the lawsuit in the first place.

  2. Form general partnerships

    Any general partner can be held personally liable for anything any other partner does. There are no protections in general partnerships — risks to your clients' wealth increase exponentially with each additional partner. Instead, consider having your clients form a limited liability corporation (LLC), which generally divides liabilities up between partners and potentially offers charging order protection (except for single-member LLCs).

  3. Form sole proprietorships

    Owning a business in this way puts your personal assets at high risk. For example, if someone gets sick at your client's hot dog stand, that person can go after your client's home.

  4. Mix liability-generating assets in the same entity

    A construction business also owns its buildings and other assets. If the business gets in trouble, the assets are at risk. Use entities to separate them.

  5. Put too much faith in one “bulletproof” asset-protection plan

    Many asset-protection plans and products have been aggressively marketed and have failed miserably when challenged in court.

  6. Skimp on insurance

    Insurance not only softens the blow of losing a lawsuit, but generally provides your client with a defense. This feature (in a right-and-duty to defend clause) adds significant value to a liability or umbrella insurance plan.

  7. Flaunting wealth

    Big game gets hunted.

  8. Using foreign asset-protection trusts to evade taxes

    It doesn't work. If you do not disclose income from foreign sources, you can be criminally charged.

  9. Buying asset protection out of a box

    Because state laws vary — and documents must be updated regularly to keep up with changing case law — asset protection isn't something that lends itself to packaging.

  10. Waiting

    If your client transfers assets after a lawsuit is expected, the courts will undue the whole thing as a “fraudulent conveyance.” This is a powerful “act now” factor for reps to point out.

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