5 Things You Can Do to Protect Your Assets Before You Get Sued
No one plans to get sued. But sometimes the unexpected happens. You get in a car accident. Your decaying oak tree collapses onto your neighbor’s roof. A former business associate accuses you of breaching a contract. Your poodle, Mister Schnookums, bites some little brat in a park. You get the point.
If your opponent obtains a judgment against you, he can probably pursue your personal assets to satisfy the judgment. This may include bank accounts, wages, real estate, vehicles, boats, personal items, and more.
In this article, I will discuss five steps you can take to protect your assets before you get sued. Once you get sued (or, depending on the state, threatened with a lawsuit), things get a lot trickier. In many (if not all) states, courts have power to declare certain transfers of money and property to be fraudulent or otherwise invalid. These laws are designed to prevent defendants from evading their responsibility to pay judgments. 43 states have passed laws similar or identical to the Uniform Fraudulent Transfer Act (UFTA), which invalidates certain transactions that occur during an active or imminent lawsuit. For this reason, you should start your asset protection plan well before you get sued—as in right now.
Be mindful that laws pertaining to personal liability and judgment collection differ among states. Make sure you read this disclaimer before continuing this article. Do yourself a favor and consult with an attorney licensed in your state to make sure you do everything you can to protect yourself.
1. Make sure you have adequate insurance.
For most people, the two most important insurance policies are: Automobile liability insurance and homeowner’s insurance (renter’s insurance if you do not own a home). For each policy, make sure you thoroughly understand what your policy limits are, what your policy covers, and which exclusions apply.
Automobile liability insurance
Automobile liability insurance covers you in the event you negligently cause someone injuries, death, or other damages (e.g., property, loss of wages, etc.). It is mandatory in almost every state.
Every insurance policy has policy limits. These are limits on the amount the insurance company will pay for a specific loss. For example, let’s say Daphne Driver has the following policy limits: $50,000 for bodily injury and $10,000 for property damage.
While texting and driving, Daphne smashes into Mario Motorcycler, shattering half the bones in his body. Mario’s medical bills are $70,000 and his $13,000 motorcycle is destroyed. The most the insurance company will pay is $50,000 for Mario’s bodily injuries (out of $70,000) and $10,000 for his property damage (out of $13,000). This means that Daphne may be held liable to Mario for the $23,000 difference ($20,000 for bodily injury; $3,000 for property damage). Daphne would have been better off getting a policy with higher limits; however, she would have paid more in premiums (i.e., payments). Insurance is always a tradeoff. Higher premiums mean less risk—and vice versa. It is up to you to evaluate your needs and appetite for risk and to select the appropriate insurance policy. It is not always an easy decision!
In addition to verifying that you have adequate policy limits, make sure you read and understand the exclusions in your policy, if any. Exclusions are provisions in the policy that eliminate insurance coverage for certain losses. What this means is that the insurance company will not pay under these circumstances. Every policy has its own exclusions, but I will go over two important exclusions: (1) excluded drivers, and (2) business use.
Let’s start with excluded drivers. I am often shocked to see how many people do not realize until after an automobile collision that their own children are excluded drivers under the policy. Read your policy thoroughly and/or contact your insurance agent to find out if anyone is excluded under your policy. If someone is excluded, they must NEVER drive your car, not even for a short drive to pick up tacos. No taco is worth personal liability!
The second exclusion is the business use exclusion. If you use your car for work (e.g., pizza delivery, dog grooming, transporting people), make sure your automobile policy does not exclude business use. If it does and you get in an accident, there is a high probability the insurance company will refuse to pay. You may need to purchase additional coverage to insure you for potential business-related accidents.
Beyond covering the structure and contents of your home, homeowner’s insurance has the added benefit of providing you with liability coverage for a wide array of potential claims. Here are a few examples of claims that might be covered:
- Your tree falls and causes damage to your neighbor’s roof
- Your dog bites someone
- Someone slips and falls on your icy porch
- Your kid’s baseball shatters your neighbor’s window
- Your washing machine floods and destroys the neighbor’s priceless Persian rug
As with any other insurance policy, make sure you have sufficient policy limits and that you understand the exclusions to the policy. If you operate a business out of your home (e.g., day care) make sure you are either covered under your homeowner’s policy (this is rare) or get a separate business/commercial insurance policy.
2. Form a trust to hold your assets.
A trust is a legal entity that holds assets for the benefit of beneficiaries. It is managed by a trustee, who has all the legal obligations and control over the trust’s funds and property, and must govern it according to the terms of the trust, and for the benefit of the beneficiaries.
There are several types of trusts that can be used to protect your assets from creditors (e.g., asset protection trust, qualified personal residence trust, life insurance trust, etc.). Generally, to protect your assets from a judgment, the trust must be irrevocable. What this means is that you cannot “cancel” it or have any control over the assets.
Typically, for a trust to shield your assets, a trustee (other than you) must have the discretion to make any and all disbursements. When creating the trust, you would specify the terms and parameters in the trust document, and the trustee then governs the trust according to those terms.
Forming a trust can be complicated. Strongly consider consulting an attorney licensed in your state to evaluate your circumstances and determine the best options for you.
3. Form a corporation or limited liability company to protect your personal assets from business creditors.
If you own all or part of a business, whether as a sole proprietor or in a general partnership with someone else, you may be exposed to unlimited personal liability for the business’s debts. If you are in a general partnership, you could be liable for the poor business decisions of your partners. You may even be liable for fraud and criminal acts committed by your partners. For these reasons, a general partnership can be very risky—exposing you to a great deal of personal liability.
To protect yourself from personal liability, consider forming a corporation, limited liability company (LLC), or limited partnership (LP) for your business. Doing so will, in most cases, reduce your exposure to your business investment. Before you do anything, research your state’s laws or consider hiring an attorney or accountant specializing in entity formation and taxation.
4. Contribute to retirement accounts.
Need another reason to contribute money to a retirement account? Retirement accounts (401(k), 403(b), IRA, etc.) have certain protections that prevent creditors from reaching them. This is especially true for plans governed by the Employee Retirement Income Security Act (ERISA), which covers an overwhelming majority of employer-administered plans.
Qualified plans governed by ERISA enjoy an unlimited protection from creditors (except the IRS and child support). There are also protections for retirement plans not governed by ERISA, though these are somewhat less extensive. Non-ERISA IRAs, for example, have a protection cap of $1 million (adjusted for inflation) from bankruptcy proceedings.
5. Take advantage of real estate protection laws.
Homestead exemptions protect the equity in your principal residence (not investment properties) from seizure by creditors. Homestead exemptions differ from state to state. In a small number of states, homeowners enjoy an unlimited homestead exemption. Check the law in your state to determine whether you are one of those lucky few!
Depending on your state’s law and your personal financial situation, it might make sense for you to pay additional principal on your mortgage rather than keeping it in your bank account. For example, if you have put $50,000 into your house (down payment, mortgage payments, etc.) but your state has a $100,000 homestead exemption, it may make sense for you to invest available funds in your home rather than a bank account, which can be seized by creditors.
Lastly, check to see how your house is titled. Some states allow for married couples to take title as tenants by the entirety. Under this ownership structure, each spouse has an indivisible share of the property. This means that both of you must consent to any sale or conveyance. If a creditor obtains a judgment against you, he may not be able to force you to sell the house without your spouse’s permission. However, if both you and your spouse are sued, this protection would not be particularly helpful.
Protecting your assets will require some time investment and planning—but it is achievable. You may need to spend some money to consult with an attorney, accountant, or to obtain additional insurance coverages.
There is no magic trick to guarantee that no one will ever seize your assets. As with everything in life, it is impossible to anticipate every possible scenario. Nevertheless, if you plan ahead and do your homework, you can put yourself in the best possible position to protect your assets from creditors.