by Shane Flait
Protecting your assets from unfair or unjust complaints is an important part of financial and estate planning. But before constructing a comprehensive asset protection plan, you should know what protection the government offers for 4 investment categories. Below, I overview from whom you are - and are not- protected and some limitations for these 4 investments categories: qualified plans, life insurance, annuities, and your homestead.
Qualified plans carry protection under bankruptcy Qualified plans are the tax-advantaged plans whose rules are regulated by the federal government. These plans are geared to induce people to save a portion of their working income for use during retirement. They include all the defined-benefit and defined-contribution employer retirement plans. I include your IRAs - traditional or Roth versions - with them, too.
These plans carry federal protection against creditors under bankruptcy. They don't carry protection against government tax claims or domestic relation claims associated with divorce or child support.
All the employer retirement plans have unlimited creditor protection in bankruptcy. Your personal IRA or Roth IRA is protected but only up to $1 million dollars - unless it was fully funded by a rollover from a company plan.
The remaining investment protections of these are regulated by the state. But the amount and nature of the protection varies with each state. So you need to check your own state's rules. Nevertheless you should be aware of what the issues are for each investment.
Qualified plans - short of bankruptcy claims For any legal action short of bankruptcy, your state law determines how much protection your qualified plan assets have. State laws vary on protection offered for:
* plan withdrawals,
* inherited plans to beneficiary
Most states will exempt qualified plan assets but only while they're in the retirement account. Some states, though, limit the exempt from creditor actions. The limit may be $200,000 or what is 'reasonably necessary' to support the owner and his or her dependents while satisfying some of the creditors' claims. Of course, the phrase 'reasonably necessary' promotes litigation by claimants.
Your IRAs can be vulnerable. Depending on how must protection your state gives to individual IRAs, your assets may be better off in your company plan than rolled over into your IRA.
Life insurance and Annuity Protection Again, these are regulated by your state's laws. Some will protect the cash surrender value of life insurance as well as annuity payments from creditor claims. Other states will restrict protection only for a beneficiary's interest necessary for his support.
As an example, those states with good asset protection protect the owner's cash value against creditors of the owner. Bad states will either not protect the life insurance at all, or just protect proceeds that are paid to beneficiaries when the insured dies. In the latter case, the beneficiary really has little protection since the creditor can gut the cash value of the contract leaving little or nothing for the beneficiary.
Likewise, exemptions for annuities don't always protect the owner's cash value in the annuity. So, to benefit by the exemption, the owner has to annuitize the annuity and start taking payments. Also if there's a state exemption allowing annuity payments for your "support", beware that this may leave you with a very small amount.
Homestead exemptions The extent to which your homestead - i.e. your main living residence- is protected is determined by your state's Homestead Act; and this varies greatly among the states. So you'll need to check out your state's limit.
Realize that your vacation or second home isn't protected by a state homestead exemption. And a homestead exemption doesn't protect you from a federal tax lien.
An estate planning conflict with state exemptions Generally, for state exemptions to protect you, the protected asset must be held in your own name. But then, those assets are trapped in your estate for purposes of federal estate taxes. And for large estates, the federal estate taxes can take up to 55% of the value of those assets.
So the wealthy should forget about state exemptions in favour of transferring their assets to trusts or other entities for the benefit of their heirs. These devices may be better for protecting them from future creditors as well as the ravages of federal estate tax.
Remember, you'll find very little or no protection under government exemptions for claims against you for taxes and domestic relations orders - such as child support. Such claims affect the majority of people. Nevertheless these 4 investment categories above can be helpful in your asset protection program for some of your assets.
Shane Flait is a writer and consultant on financial, legal, tax, and retirement issues. He explains the issues and gives you workable strategies to accomplish your goals. Find out more and get a free report on Managing Your Retirement => http://www.easyretirementknowhow.com/FreeReportandSignUp.htm
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