Wealth preservation is one of the most sought after and value added segments of family office services, as retention of net worth is paramount in most family priorities. Wealth preservation is the holistic approach adopted by family advisors to achieve the common goals of asset protection, manageable structure, minimization of risk, and magnification and eventual transition of wealth.  

While most families begin their foray into the business world with the goal of amassing as much net worth as possible, many are surprised that upon reaching a level of success that it can often be more difficult to hold on to wealth than it was to earn it. With the increasing complexity of wealth, and the need to coordinate professional activities, the family office has evolved as the central advisory source.  

An important subset of wealth preservation is the field of asset protection. Due to its popularity, other planning areas have begun to use the phrase, sometimes distorting its definition. Some use “asset protection” to sell casualty insurance, lower risk investments, prenuptial agreements, wills, and many more tangentially related areas.

At its core, asset protection is the use of legal entities, structures, and strategies to make assets difficult or impossible for a potential creditor to reach.  Asset protection planning often has strong estate planning benefits but does not involve a specific product, insurance, or tax ideas. The aim of asset protection is to mitigate the risk to family net worth posed by creditors, predators and divorce and works best when coordinated with a comprehensive wealth preservation strategy.

The purpose of this article is to outline foundational concepts of wealth preservation and asset protection and their practical applications in the family office arena.

Sources of Liability

Preserving net worth is not new. The topic is at the forefront of many family’s planning goals as litigation in the United States has dramatically expanded. Liability stems from areas where the family and advisors may not have known an issue was developing. Some of the fastest growing areas of litigation are less obvious – social liability (parties, events, guests), employment practices (discrimination, harassment, noncompliance), empowerment (actions which “aided” the actual wrongdoer), management (director, officer, advisor). Many are left wondering how the court system and jury allow seemingly tenuous cases to produce seven figure judgments. Lawsuits typically follow asset ownership rather than actual wrongdoing as every plaintiff seeks “deep pockets” at the table. Asset protection aims to remove the deep pocket target and make one unattractive to a creditor.

Timing and Effectiveness

Managing risk occurs before a claim is made. Asset protection is effective against future creditors and can be penetrated by an existing creditor one knows of or reasonably should have known of. Insulation can still often be achieved after the fact, but is limited in application and becomes significantly more complicated.

Integration

The most effective planning involves integration of overlapping areas that affect a family
net worth; estate planning (incapacity, death disposition, reduction of probate, reduction of death taxes, guardianship, managing inheritances), tax planning (leverage, income tax shifting, maximum use of transfer credits, coordination of federal/state death taxes), business planning (exit strategy, key person retention, company structure, perpetuation), insurances (shifting risk, funding tax burdens), asset titling, entities, etc. to be arranged and implemented in an easy to live with fashion.

Concepts that are familiar in investment planning are integral in asset protection as well; segregation and diversification. Few manage assets in one investment house or in one class of assets. Similarly, asset protection is not one technique or one entity, rather it is the use of combinations of strategies to achieve insulation, tax efficiency, and control.  

Risk Shifting

The way we own and manage assets is directly related to the ability of a court and plaintiff to attach to them.  We often see families shift asset ownership to a spouse (who perhaps does not work or has a lower risk profession), children, or other family members. In effect this is not reducing risk in as much as it shifts risk. The non-working spouse owning the home shifts the risk to the social events, household help, and guests of the home. There are still the car accidents, libel, divorce, and other potential actions against that family member. If there is a difference of opinion, the asset earner does not have direct control, which often creates family rifts.

Corporations

Corporations have been popular for a long period of time but serve a very limited purpose. The common perception is that corporate assets are insulated. To a large extent this is not the case. A corporation’s assets are fully reachable by a plaintiff with a claim against the corporation. A corporate entity is intended to shield shareholders from personal liability, however, many times the corporate veil can be pierced and personal liability attaches. There are more powerful and flexible choices for a company.

Insurance

Liability insurance is a common tool and a useful one. However, despite the many items the agent advises it covers, the list of risks it does not cover is far longer (i.e. divorce, employment practices, acts of adult children, intentional torts, business disputes). Diversification becomes apparent "liability coverage is a component – but should not be seen as the only defense.

Let’s briefly touch on some of techniques that serve our asset protection goals.

LLCs and FLPs

The very popular limited liability companies (LLCs) and family limited partnerships (LPs) share similar insulation qualities – state statute prohibits a creditor of an owner from putting liens on LLC/LP assets. Creditors are left with the choice of trying to prove the entity is a sham (generally difficult unless the owners were quite lax) or attempting to obtain a charging order – an award of the debtor owners share of profits. A charging order is usually of no value as the debtor is the sole management and determines when, and if, profits will be distributed. This does not preclude the owner from making loans to himself/herself, taking salary/bonuses, shifting profit to other uninvolved entities via leases, consulting arrangements, etc. While one entity is simplest, if there is a problem asset or claim, the other assets of the same entity can be affected. Thus, most plans segregate assets in various entities.

Trusts

Trusts are often discussed as if it were a single purpose tool but trusts have many dozens of variations, each with significantly different features, control, tax treatment, and insulation qualities. Revocable trusts, sometimes known as living trusts, are alternatives to a will and serve disposition and probate avoidance goals and offer no protection at the client’s level (though it can protect younger generations). Irrevocable trusts often are used to own life insurance policies, or serve as receptacles for gifting, and can protect assets. However, insulation relies on separating the asset transferor from control, a point often missed and families are surprised that they cannot control or modify the trust or, if they retained control, that there is no protection. Grantor trusts usually serve as a deferred gifting tool; give assets away but at a later time to reduce the taxable amount of the gift. However, many put assets directly in children’s hands which shifts control to the children and exposes the assets to the children’s claims and divorces. Asset protection trusts (available in several US states and multiple other countries) can be very powerful asset insulators. If structured well they can be treated as US trusts for income tax purposes (avoid the draconian foreign rules) and foreign for claims (not subject to US courts) and coordinate with death taxes. Since asset protection is a subspecialty, and the rules are fairly complex, many trusts focus on one goal and inadvertently create significant problems on other related planning fronts. The scope of this article does not allow us to detail the many varieties of trusts but aims to emphasize that trusts are a valuable arrow in the asset protection quiver but are one of the most misapplied tools.