Asset Protection Trusts

Apparently Lauree has already fielded a question from a physician if he should look at adopting a Michigan Qualified Dispositions in Trust, aka ‘asset protection trust?’ Lauree could have predicted my lawyer-like answer: “It depends.”

My sense is that I would not immediately recommend an asset protection trust to a client unless I had already gone through a process of elimination.

For example, all retirement accounts and IRAs are exempt from levy and attachment by creditors due to ERISA and Michigan statutes that exempt those assets from creditor claims. No need for a trust to protect them.

If the client’s home is owned as tenants by the entireties with his or her spouse, the equity in the home should also be sheltered from the creditor claims of one spouse. No need for a trust to protect entireties assets.

Other assets would not be good candidates to transfer into the asset protection trust because they bring with them high risks that could expose other assets also held in the trust, e.g. a private airplane; a producing oil well. Those assets that are risk oriented would more likely be isolated from other conventional assets in separately owned LLCs or purpose Trusts, where they are the sole asset. Consequently these assets would not qualifty.

Probably the most likely asset at risk to a creditor’s judgment would be an investment account in the client’s name alone, or an investment account that is owned as joint tenants with their spouse [which is not the same thing as ownership by the entireties.]

But before I would explore creating an asset protection trust and transferring the investment account into that trust, I would look at the possibility of a couple of other options:

The investment portfolio could be transferred to an LLC. The membership units in the LLC could be owned by spouses as tenants by the entireties; Michigan’s limited liability company statute permits that form of ownership. As noted, if the creditor has the judgment against one spouse, but not both spouses, then arguably the entireties owned membership interest might thwart the creditor’s collection efforts. But there is a strong belief that a single member LLC does not provide any protection to the single member who faces a judgment creditor. And since tenants by the entireties is viewed by statute and the common law as ownership by a single legal entity (a married couple) probably the investment account held in the name of the LLC owned by the spouses by the entireties will not provide the creditor protection that would otherwise be available if there were two or more members of the LLC. A handful of states, e.g. Nevada, specify in their LLC statutes that a single member LLC enjoys the same creditor protection as would a multiple member LLC. Michigan’s LLC statute, as I read it, does not extend the same type of creditor protection to a single member LLC, at least not yet.

Other ‘investment’ vehicles also enjoy statutory creditor protection [assuming the Uniform Fraudulent Transfer Act and its badges of fraud is not readily available to set aside the transfers.] What if the client liquidated their investment account and purchased a single premium life insurance policy? A young physician might consider this an appropriate investment as an income replacement

My sense is that I would not immediately recommend an asset protection trust to a client unless I had already gone through a process of elimination.

But before I would explore creating an asset protection trust and transferring the investment account into that trust, I would look at the possibility of a couple of other options:

The investment portfolio could be transferred to an LLC. The membership units in the LLC could be owned by spouses as tenants by the entireties; Michigan’s limited liability company statute permits that form of ownership. As noted, if the creditor has the judgment against one spouse, but not both spouses, then arguably the entireties owned membership interest might thwart the creditor’s collection efforts. But there is a strong belief that a single member LLC does not provide any protection to the single member who faces a judgment creditor. And since tenants by the entireties is viewed by statute and the common law as ownership by a single legal entity (a married couple) probably the investment account held in the name of the LLC owned by the spouses by the entireties will not provide the creditor protection that would otherwise be available if there were two or more members of the LLC. A handful of states, e.g. Nevada, specify in their LLC statutes that a single member LLC enjoys the same creditor protection as would a multiple member LLC. Michigan’s LLC statute, as I read it, does not extend the same type of creditor protection to a single member LLC, at least not yet.
Other ‘investment’ vehicles also enjoy statutory creditor protection [assuming the Uniform Fraudulent Transfer Act and its badges of fraud is not readily available to set aside the transfers.] What if the client liquidated their investment account and purchased a single premium life insurance policy? A young physician might consider this an appropriate investment as an income replacement to support the physician’s spouse and children should the high earning physician suddenly die. The cash surrender value of a whole life insurance contract is generally exempt from creditor claims if the insured’s close family members are the named policy beneficiaries. There are some not-so-hidden costs associated with this purchase of a single premium life insurance contract, such as the capital gains recognized if the investment portfolio is liquidated to raise cash to pay the premium, or that a lump sum single premium life insurance policy is treated as a modified endowment contract [MEC] which means that the cash surrender value cannot be accessed tax-free to the policy owner for the first 7 years of the policy’s existence. An annuity could also be purchased using the lump sum, but there are greater commission costs incurred in the purchase of the annuity including those noted with the purchase of a single premium life insurance contract.
Or, the conventional estate planning spousal lifetime access trust {SLAT} could be used to transfer the portfolio assets in-kind [thus no need to liquidate the portfolio to convert it to cash] where the SLAT’s income and principal could still be made available to the spouse, and thus indirectly the settlor, without having to jump through all of the hoops that the Qualified Dispositions in Trust Act requires. Secured loans could also be made from the SLAT to the settlor or his/her spouse if permitted under the terms of the Trust.

My point is that rather than immediately reach for an asset protection trust as the ‘first’ solution, in-vogue as they may be for awhile, other options need to be explored first, not to mention the size of the asset that arguably needs the protection. If most folks these days have the lion’s share of their wealth tied up in IRAs and 401k accounts, or in cash surrender values of life insurance policies, then a balance needs to struck weighing the costs and restrictions of setting up the asset protection trust against the value of the assets that are to be protected by it.

to support the physician’s spouse and children should the high earning physician suddenly die. The cash surrender value of a whole life insurance contract is generally exempt from creditor claims if the insured’s close family members are the named policy beneficiaries. There are some not-so-hidden costs associated with this purchase of a single premium life insurance contract, such as the capital gains recognized if the investment portfolio is liquidated to raise cash to pay the premium, or that a lump sum single premium life insurance policy is treated as a modified endowment contract [MEC] which means that the cash surrender value cannot be accessed tax-free to the policy owner for the first 7 years of the policy’s existence. An annuity could also be purchased using the lump sum, but there are greater commission costs incurred in the purchase of the annuity including those noted with the purchase of a single premium life insurance contract.

Or, the conventional estate planning spousal lifetime access trust {SLAT} could be used to transfer the portfolio assets in-kind [thus no need to liquidate the portfolio to convert it to cash] where the SLAT’s income and principal could still be made available to the spouse, and thus indirectly the settlor, without having to jump through all of the hoops that the Qualified Dispositions in Trust Act requires. Secured loans could also be made from the SLAT to the settlor or his/her spouse if permitted under the terms of the Trust.