Perhaps the biggest single financial tragedy would be to build up substantial net worth, only to have it seized as part of a legal action against you. All of your hard-earned assets will go right down the drain in a single court decision. But you can learn how to protect your money from lawsuits and other legal grabs. You just have to use a few of the right strategies to make it happen.
Try using these to protect your assets.
Maintain Adequate Insurance Coverage
Insurance is your first and best defense against lawsuits and legal claims because it exists largely for that purpose. It creates a layer of financial insulation between you and a claim for damages.
Make sure that you have adequate coverage in regard to homeowners, auto, life, health, and especially business insurance. “Adequate” refers not to government required minimum coverage, but rather an amount of coverage that is sufficient to protect the level of assets that you have. It’s sad to say, but you have to consider the possibility of a lawsuit when setting your coverage limits.
In addition to these more typical insurance policies, you might also give serious consideration to getting umbrella coverage. This is a type of rider that provides additional coverage in the event that your regular insurance policies prove insufficient for the challenge that you’re facing.
The coverage is relatively inexpensive and can be had in a face value of up to $5 million. In the event that a legal claim exceeds the maximum coverage that you have under another insurance policy, the umbrella coverage will pay the difference. That may be enough to prevent a plaintiff from going after your financial assets, and even your home or business.
Incorporate Your Business
If you are self-employed, then you may need to consider turning your business into a distinct legal entity, that way your personal assets will be protected in the event of legal action.
Incorporating your business is one way to do this. Under a corporation, your personal assets will be protected in the event of an action against your business.
The other alternative is to set up a limited liability company, more commonly known as an LLC. These can protect your personal assets from actions against your business in much the same way that a corporation does. The advantage, however, is that an LLC has fewer restrictions than a corporation, which is why they have become such a popular form of business ownership.
Since legal action is probably more likely to come against your business than against you personally, setting up a corporation or an LLC is an excellent line of defense.
Qualified retirement plans aren’t just an excellent way to save money for retirement and accumulate a large asset base. They can also shield your money from legal claims and creditors.
In general, assets held in a qualified retirement plan, such as an IRA or 401(k), are protected from legal action, including a bankruptcy filing. Laws vary from state to state, but the courts have generally held that retirement plans are beyond the reach of plaintiffs and creditors.
Set Up a Trust
This is probably the single best step that you can take to protect your wealth, particularly if you have a substantial net worth. It’s not possible to put all of your wealth into qualified retirement plans or even necessarily to protect it through insurance. A trust is a way to protect everything else that you have.
You can set up an irrevocable trust that will protect your assets from legal challenges and claims from creditors. This is sometimes referred to as a living trust, or an inter vivos trust, since it is created while you are still living.
An irrevocable trust as three primary provisions:
- It cannot be amended or canceled by you,
- The trust must have a separate trustee, and cannot be controlled by you, and
- It must file its own income tax return.
An irrevocable trust effectively creates an entirely separate and distinct legal entity. It moves ownership and control of your assets away from you personally and puts them under the control of the trust itself. Any assets that are held in the trust are exempt from claims by plaintiffs or creditors. This can even include life insurance policies held inside a trust.
There’s also what is known as a revocable trust. Despite the similarity in the names, a revocable trust does not provide a similar level of legal protection to what you will have with an irrevocable trust. Within a revocable trust, you retain control over the assets within the trust. You can also amend or even cancel the trust, and have the income flow through to you personally.
The courts generally hold that since you retain effective control over assets within a trust, that they are part of your personal wealth, and as such, they can be included in a lawsuit or even in claims by creditors.
If your assets have been growing, and certainly if you have a net worth in excess of $100,000, you should be thinking of how to protect your money from lawsuits and other legal grabs. Use the strategies in this article, and take a long hard look at setting up an irrevocable trust.