The Sliding Scale of Asset Protection
The most common misconception among Doctors regarding asset protection is the idea that an asset is either “protected” or “unprotected.” This “black or white” analysis is no more accurate in the field of asset protection than it is in the field of medicine. In fact, asset protection advisors are very similar to physicians in how they approach any client or patient. In this chapter, we will discuss the way in which advisors measure a client’s assets by using a sliding scale. Then we will suggest ways in which Doctors can protect assets, avoid high-risk assets and achieve a high level of protection.
The Sliding Scale And Scores
To measure the assets of a client, advisors use a sliding scale that indicates the client’s “good” and “bad” financial habits. Like Doctors, asset protection professionals will first try to get a client to avoid “bad habits.” For a medical patient, bad habits might mean smoking, drinking too much or maintaining a poor diet. For a client of ours, bad habits might include owning property in their own name, owning property jointly with a spouse or failing to maximize the percentage of exempt assets in an investment portfolio.
Like a Doctor who judges the severity of a patient’s illness, asset protection specialists use a rating system to determine the protection or vulnerability of a client’s particular asset. The sliding scale runs from-5 (totally vulnerable) to +5 (superior protection). As you have probably already guessed, our goal is to bring a client’s score closer to (+5) for each of their assets.
When most clients initially come to see us, their asset planning scores are overwhelmingly on the negative side of the scale. The reason for this score varies. Typically, personal assets are owned jointly (-3) or in their individual name (-5). Both of these ownership forms provide little protection from lawsuits and may also have negative tax and estate planning implications.
Many medical practices themselves also have asset planning scores that are overwhelming negative. For practices, the worst way to operate a business or title assets is a general partner-ship (-5). For all other business entities, liability from operations is always a concern. For this reason, owning any business assets within an operating business is extremely unwise (-5).
Before asset protection specialists can achieve a high level of protection for their clients, they must first eliminate the high risk assets. There are many ways to protect assets, but the most efficient way to avoid high risk assets and achieve a high level of protection is to utilize exempt assets. This is mentioned briefly in the next section and then discussed in greater detail later in the Lesson.
The Best Protection: Federal. & State Exempt Assets
Each state law identifies assets that are absolutely exempt from creditor claims in that state. Federal law also exempts certain assets. Because these assets are inherently protected by law, they enjoy the highest level of protection, a (+5) score on the sliding scale. These will be discussed in detail in Chapter 6-6.
Good examples of how state laws can protect assets are found in Texas and Florida, where the homestead exemptions are unlimited for personal residences (within certain rules) and the cash value in life insurance policies is completely protected. In California, as you will see, our rules are not as protective. At the federal level, bankruptcy law affords (+5) protection for qualified retirement plans, like pensions and 401(k) plans.
Basic Domestic Legal Tools
In many states, the list of state exemptions is not very generous—particularly in California! Even in those states where the exemptions are broad, we need to make sure that the asset protection goals are balanced with wealth accumulation and investment goals. For these reasons, there will almost always be non-exempt assets in a client’s asset mix. For these assets, we must use other protection tools.
In such a situation, the basic asset protection tools are family limited partnerships (FLPs) and limited liability companies (LLCs). FLPs and LLCs provide good asset protection against future lawsuits, allow you to maintain control and can provide income and estate tax benefits in certain situations. For these reasons, we call FLPs and LLCs the “building blocks” of a basic asset protection plan.
FLPs and LLCs afford asset protection scores somewhere between (+1) to (+3), depending on the circumstances.
Other Protection Strategies
Most Doctors can achieve the majority of their asset protection planning with a combination of exempt assets and legal tools (like FLPs, LLCs, and Trusts). However, Doctors who are worth more than $3,000,000, or who earn more than $500,000, almost always need additional planning strategies to help them protect their assets. More successful Doctors may utilize advanced techniques like:
Certain Non-Qualified Plans used in a medical practice may provide asset protection benefits vis-a-vis creditors of the physician. In addition, these tools can offer tax-deferral and estate planning benefits. Most Doctors find these tools attractive because employees need not be covered in these plans to be successful. Revisit Chapter 5-4 for more on these tools.
Captive Insurance Companies
Structured offshore or domestically, Captive Insurance Companies can also reach the (+5) status when the shares are owned by a second entity like an irrevocable trust. Successful businesses can use such insurance companies to provide superior asset protection, risk management, efficiently fund a partner buy-out and potentially reduce income and estate taxes. This strategy was dis¬cussed in greater detail in Chapter 5-6.
Debt Shields And Collateralization
Debt Shield and Collateralization strategies are ideal for protecting equity in real estate, especially the personal residence and the medical practice’s Accounts Receivable (AR). This technique helps achieve a (+1) to (+5) rating. The exact score depends on the funding vehicles used in this technique. When structured properly, after-tax wealth can be built while protecting the real estate equity or Accounts Receivable in a superior way.
Asset protection planning, like any sophisticated multi-disciplinary effort, has degrees of success. Nothing in life is 100% certain (except perhaps death and taxes—both of which are discussed in Lessons #9 and #7, respectively). For asset protection planning, this adage holds true. You can protect each personal or practice asset to different levels. Exempt assets offer the greatest level of protection with the least cost. Legal tools generally fill in the rest of the plan for the average Doctor. Successful Doctors may choose to add Debt Shields, Captive Insurance Companies or Non-Qualified Plans to complete the planning.
In your asset protection plan, make sure you understand the benefits and consequences of the various tools you employ. Your asset protection advisor can help you weigh the pros and cons of each potential strategy. Your advisory team can help explain how each asset protection strategy or tool may be integrated into your comprehensive financial plan. By addressing your asset protection concerns as part of comprehensive planning process, you will not only protect the wealth you have already built, but you may find more efficient ways to build greater after-tax wealth for your retirement and for future generations.