Editor’s Note: Eldridge D. Dodson, John R. Sloan and Matthew W. Thompson are all members of the Trusts and Estates Practice Group at Ward and Smith, P.A.

Protecting your assets from potential creditors always should be a major planning consideration. In tough economic times, however, asset protection becomes an even more compelling objective. Asset protection planning includes an asset-by-asset review to determine what assets already are protected from creditors and what additional assets can be protected through affirmative action.

When to Plan

Asset protection planning can be very beneficial, especially when economic times are difficult. If creditors are knocking at the door, however, it probably is too late to plan. Protection strategies implemented after a claim is made (or even anticipated) generally can be negated by courts as "fraudulent conveyances." Therefore, the sooner planning is considered and completed, the less likely it is that a creditor can argue successfully that the plan was designed to fraudulently avoid creditors’ claims. Acting in advance (as opposed to engaging in last minute, likely ineffective efforts) also allows for a reasoned, thorough plan that is consistent with other planning goals.

Automatic Protection

Many are surprised to learn that some assets are protected from creditors’ claims as a matter of federal and North Carolina law. Therefore, an "asset protection plan" for an individual who owns only these types of assets can be very simple. A plan also can include increasing investment in assets that enjoy automatic protection. Some examples of "protected assets" are:

• Real Estate Owned With Spouse. In North Carolina, real estate owned jointly by spouses as "tenants by the entirety" is protected from claims against an individual spouse. This protection applies not only to a residence, but also to investment, commercial, and rental real property. "Tenancy by the entirety" protection, however, is not absolute. For example, a creditor of both spouses can access the real estate. Moreover, if one spouse dies, all interest in the entirety property will pass automatically to the surviving spouse as that spouse’s individual property. An existing claim against the surviving spouse then could be enforceable against the property. Furthermore, tenancy by the entirety protection terminates upon divorce.

• IRAs and Retirement Plans. IRAs and qualified retirement plans are exempt from the claims of creditors under federal and North Carolina law. Therefore, one asset protection technique is to maximize contributions to retirement accounts. Although amounts withdrawn at retirement age might be subject to claims, many creditors will not pursue a claim that cannot be realized until the distant future.

• Life Insurance. Life insurance policies payable to a spouse or child enjoy protection from creditors under North Carolina law. This exemption applies to both the cash surrender value of the policy and the death benefits.

Affirmative Steps

Although some assets are afforded automatic protection from creditors, others are not. More extensive planning may be appropriate for individuals owning assets that are not protected automatically. The following methods of affirmative asset protection warrant consideration in this circumstance:

• Insurance. Many potential claims are apparent. Insurance may be available to address them. Acquiring insurance often is the easiest and most efficient method of protecting assets. For example, obtaining adequate automobile, homeowners, malpractice, and umbrella insurance coverage substantially reduces the level and type of creditor risk that an individual may face. In some cases, however, insurance may be unavailable, insufficient, or impractical.

• Gifts to spouse or children. A creditor typically can reach only those assets owned by the individual or entity subject to a claim. Therefore, an effective strategy can be to transfer assets to a spouse or child who faces less inherent risk. For this strategy to be successful, however, the individual who makes the gift must surrender complete ownership of the asset. Joint ownership, other than "tenancy by the entirety" for real estate as addressed above, provides only limited protection. Although transferring assets to a spouse or child can be an effective asset protection technique, other consequences of the transfer should be considered. For example, gifts to a spouse can impact asset division upon divorce. Additionally, there can be gift tax consequences for transfers to children. Proper planning, though, can avoid these issues.

• "Spendthrift" trusts. An outright gift may not be an attractive option if the potential recipient of the gift is too young, immature, or has risk. Use of a trust to hold the assets for the benefit of that person can be beneficial. A properly formed trust can protect the underlying assets from any creditor’s claims. For example, if a parent creates and funds a trust for a child, the child can benefit from the trust without losing the assets in the event of a divorce or lawsuit.

• Limited Liability Company ("LLC"). An LLC is a legal entity that can own assets of, and be managed by, an individual. An LLC can own business assets such as real estate, a boat, or an airplane. The individual can control the LLC and its assets, but will not have direct ownership of the assets. This ownership separation not only can protect the asset placed in the LLC from creditors of the individual, but also can protect other assets of the individual from liability arising from the assets or operations of the LLC. However, if the individual owns the LLC, a creditor of the individual can reach the assets indirectly through the individual’s ownership interest. Therefore, consideration must be given to separating the management and the ownership of the LLC. Generally, planning with an LLC or other corporate entity can provide increased asset protection.

• Trusts Formed Outside of North Carolina. Asset protection options also exist outside of North Carolina. Trusts established under laws of some states other than North Carolina or foreign countries potentially can provide additional protection not available in this state. The major benefit of relying on laws of such states or countries is the ability of an individual to create a trust for his or her own benefit for asset protection, a so-called "self-settled" trust. North Carolina law does not protect assets in such trusts. However, several states (notably, Delaware, South Dakota, and Alaska) and foreign countries (typically, islands in the Caribbean, Pacific, or English Channel), however, allow "self-settled" trusts. The benefit of such trusts must be balanced against the cost and effort required to take advantage of this opportunity. Typically, at least one trustee and some portion, if not all, of the assets must be located in the state or country where the trust is established. Trustee fees and dealing with assets located elsewhere increase both the cost and administrative burden of this asset protection technique. Domestic trusts and their corporate trustees are subject to United States laws and regulations. Foreign trusts are not. They are controlled by the laws and regulations of the foreign country. Although the ultimate benefit of both options has not been tested fully, appropriate due diligence prior to commitment to any non-North Carolina trust is critical, particularly with foreign trusts.

Conclusion

Asset protection strategies are an important part of nearly every estate plan, especially when economic times are difficult. While some assets enjoy automatic protection from creditors, affirmative steps should be considered and taken timely for an asset protection plan to be effective. As with any planning, careful consideration of the benefits and risks of asset protection planning and completion of all appropriate steps well before a potential claim arises can establish the most effective asset protection plan.

© 2008, Ward and Smith, P.A.

Ward and Smith, P.A. provides a multi-specialty approach to the representation of technology companies and their officers, directors, employees, and investors. Eldridge D. Dodson, John R. Sloan, and Matthew W. Thompson practice in the Trusts and Estates Practice Group. Comments or questions may be sent to edd@wardandsmith.com, jrs@wardandsmith.com, and mwt@wardandsmith.com.

This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.