Seven ways to protect assets with planning

By properly planning your estate, you can also avoid potential damage to your net worth from litigation, divorce, malpractice and other claims.  Some of the same techniques used to reduce estate taxes also provide protection from claims.

Of course, these measures won’t protect against existing creditors if a transfer constitutes a “fraudulent conveyance” under the Uniform Fraudulent Transfer Act.  A fraudulent conveyance occurs if you intended to hinder, delay or defraud a creditor when you made the transfer.

Here are seven ways to protect transferred assets:

Outright gifts

An outright gift to an heir protects that asset. However, you will lose all economic interest in and all control over that asset.

Family Limited Partnerships (FLPs)

An FLP is a good asset-protection option because it limits the ability of the creditor of one limited partner from attaching to a partnership’s assets to satisfy a debt.  Creditors generally can obtain a charging order against a limited partner’s interest in the partnership.

This order would let the creditor receive distributions only when they’re made from the partnership, and the general partner can control or choose not to make distributions.

Irrevocable Life Insurance Trusts (ILITs)

From the standpoint of protecting your assets, an ILIT removes insurance proceeds from your estate for federal estate purposes.  And the trust protects from creditors the cash value of the policies during your lifetime and the policy proceeds when you die.

Qualified Personal Residence Trusts (QPRTs)

A QPRT lets you transfer a primary or vacation residence to a trust while you reserve the right to live in the home for a term of years.  The value of the interest you retain (the right to live in the home for a term of years) is calculated using IRS tables.

The value of the property transferred into a trust, minus your term interest’s value, is a gift known as the “remainder interest.”  This gift can be sheltered from gift tax by your $1 million gift tax exemption.  If you survive the term of the years, the trust is not included in your estate for federal estate tax purposes.

QPRTs provide creditor protection by insulating the residence from your creditor’s claims.  In a creditor protection situation, the nondebtor spouse should create the QPRT and retain the term of the trust.

Inter Vivos Qualified Terminable Interest Property (QTIP) Trusts

You create this trust during your lifetime for your spouse, which qualifies it for the gift tax marital deduction.  The federal estate tax benefit to this technique is that when your spouse dies, the QTIP trust is included in his or her estate for federal estate tax purposes.  If your spouse lacks sufficient assets in his or her own name to use his or her federal estate tax exemption, the QTIP assets will achieve this.

If you survive your spouse, an amount of assets equal to the estate tax exemption (currently $1.5 million) will first go to fund a family trust created under the QTIP trust.  The balance of the QTIP trust assets will be allocated to the marital trust for your benefit and will qualify for the marital deduction, resulting in no federal estate tax at your death.

The inter vivos QTIP trust is extremely popular as a creditor protection device because the QTIP assets are completely insulated from claims of your creditors and your spouse’s creditors during your spouse’s lifetime.

Charitable Remainder Trusts (CRTs)

A CRT usually provides for distribution of a percentage of the trust principal, at least annually, to the grantor, for his or her lifetime and can provide for the grantor’s spouse after the grantor’s death.  When this period ends, the charity receives the remaining CRT assets (the “remainder interest”).

An additional benefit is that the CRT is exempt from all income tax.  So a grantor owning assets subject to a large capital gain can transfer these assets to the trust, and it can sell them without the grantor or the trust having to pay any tax on the gain.

Or a grantor holding highly appreciated assets that aren’t producing much income can contribute them to the CRT and create an income stream and owe tax only as annuity payments are received.  It sells them and reinvests the proceeds to service the annuity.

Grantor Retained Annuity Trusts (GRATs)

A GRAT is a gift of a remainder interest in an irrevocable trust, under which the grantor has retained an annuity interest for a term of years.  For example, if $500,000 is transferred to a GRAT and the grantor has retained a six per cent annuity, $30,000 per year will be distributed to the grantor.  The remainder interest in the GRAT can be a trust for the grantor’s spouse, with trusts being created for children when both spouses die.

If the grantor survives the GRAT’s term, its assets will be excluded from the grantor’s estate for federal estate tax purposes.  If a nondebtor spouse is the grantor of a GRAT, the debtor’s spouse’s creditors can’t attach the annuity distributions to the nondebtor spouse.  These creditors also can’t attach the GRAT principal.  If a debtor spouse becomes a GRAT beneficiary when the nondebtor spouse dies, his or her creditors could attach any distributions to the debtor spouse.

In a society rife with litigation, you simply can’t underestimate the importance of protecting yourself.  The tactics listed above are just a few of the ways proper estate planning can safeguard your assets.  You should learn all you can about these measures and others that may benefit you.