Can They Take My Retirement? Basic Asset Protection Explained

Over  time we accumulate assets. We borrow money to buy a home and repay it.  The home usually appreciates in value (except for recently). Some of  us buy CDs or stocks, bonds, and life insurance. Or we contribute to an  individual retirement account (IRA) or a 401k.

These assets can be protected from creditors to some extent.   

The  foremost way to protect assets from creditors is to avoid liability in  the first place. Being careful, conscientious, and honest is a great  way to not get sued.

Sometimes  bad things happen, even to good people. Carrying adequate liability  insurance is the next line of protection. An umbrella policy provides  coverage above and beyond the typical auto and homeowners policies.  Service professionals – like doctors and lawyers – are well advised to  carry malpractice insurance.

Separating  personal and business affairs is another way to protect oneself.  Forming a corporation or limited liability company around the business  can prevent a business debt from becoming a personal debt.

Well-structured assets is the next and last line of defense. This is where things can get complicated.

Before  suing someone, a plaintiff asks, “if I win my lawsuit, will I get  paid?” After all, a court judgment is just a piece of paper, but it can  be enforced by taking the debtor’s assets and selling them to pay the  judgment.

Here is the key: Not all assets can be taken. Only non-exempt  assets may be used to satisfy a judgment. By maximizing one’s exempt  assets, to the disfavor of non-exempt assets, there is less for a  creditor to take. This can discourage a plaintiff from filing a lawsuit  in the first place.

One  example of an exempt asset is the homestead – or at least, part of it  anyway. In Washington State, the first $125,000 of equity in one’s home  is exempt from creditors. This is commonly known as the homestead  exemption.  Other states have lower homestead exemptions, and some have  unlimited exemptions.

The  “equity” is calculated by adding up all the mortgages on the home and  subtracting that amount from the distressed sale value of the home.  (The “distressed sale value” is the amount it would sell at a  foreclosure auction.) If that amount is less than $125,000, a creditor  will not be able to take the home. That is not to say the creditor  cannot let his judgment sit as a lien and “season” over time, waiting  for the owner’s equity to increase.

If  the equity is more than $125,000, the creditor can take the home, but  the owner first gets $125,000 to keep (after the mortgages are paid) and  may put that into another home.

Individual  retirement accounts, 401ks, and life insurance policies are also  exempt from creditors. This is a great reason to maximize retirement  contributions. Not only do retirement accounts offer tax savings, but  they are protected from creditors.

Social Security income is another exempt asset.

It is a popular myth that putting assets into a trust will keep them out of reach from creditors. This is only half true.

First,  for the uninitiated, a “trust” is a relationship where one person, a  trustor, gives an asset to another, the trustee, with the expectation  that the trustee will follow the trustor’s directions in managing the  asset to benefit another, the beneficiary. In legal jargon, the “legal”  title (held by the trustee) and the “equitable” title (held by the  beneficiary) are split.

A  self-settled trust, where the trustor is his own beneficiary, is fair  game for creditors. In these situations courts look at form over  substance, and allow creditors to invade trust assets to pay the debts  of the trustor/beneficiary.

On  the other hand, non-self-settled trusts are typically exempt from  creditors. A non-self-settled trust is created when someone irrevocably  puts assets in trust for the benefit of another. Estate planners  typically advise clients to use this type of trust in order to give  children-heirs the benefit of an inheritance, while not giving them legal title. This type of trust will stymy creditors.

Another  popular myth is that gifting assets to a friend or family member will  automatically keep them from creditors. If the gift is so large that it  leaves the donor with nothing but debt, it is called a “fraudulent  transfer.” Creditors can (and often do) undo these transactions.

There  is no magic bullet to living risk-free. Being careful, honest and fair  in business is the best way to protect against lawsuits. Carrying  insurance is a must too. Maximizing one’s creditor exemptions can be  another good idea.

Leave a Reply