How to Protect Your Safe Assets

Over the years, we have heard the sad stories of clients who had their businesses protected with a separate legal entity. Still, when sued personally, they forgot or never focused on protecting their safe assets (which many times is the savings and investment accounts for their financial future) and lost ALL safe assets.

The reasons why most do not take the time to protect one of THE MOST IMPORTANT personal assets is usually a lack of knowledge and accurate information. The other has to do with faulty beliefs like, “I am a good person…who would sue me personally” (people get pretty upset with car accidents and may see you as their lottery ticket) or “I have plenty of insurance, so that SHOULD cover me” (not always; in fact, the loopholes in your policy, if you understood them, would be shocking).

Protecting Safe Assets

Let’s take a step back and define what is considered a safe asset. A safe asset is one that does not cause direct liability. In other words, your interest-earning money market account is not going to cause anyone liability the way a car, business, employee, or a piece of real estate can. Many safe assets are already protected because they are in a retirement account such as a 401(k). There are exemptions at the state and federal level that will protect your retirement accounts. For example, 401(k)’s is covered by the Employee Retirement Income Security Act, known as ERISA, and are completely protected from creditors — except when those creditors are former spouses or the I.R.S.

The bad news is that ERISA does not cover individual retirement accounts. If you have filed for bankruptcy, federal law protects up to $1-million in an IRA (individual retirement account) that you contributed to directly and protects the entire account balance if the money was rolled over into an IRA from a company plan.

For anything short of bankruptcy, state law determines whether IRAs (including Roth IRAs) are shielded from creditors’ claims.

Most states, including New York, New Jersey, and Connecticut, exempt 100 percent of the assets while they are in the account. But laws in other states vary widely on whether withdrawals are covered, whether protections extend to inheritors as well as the initial owner, and whether former spouses can reach the funds.

Some states limit how much is exempt — Nevada caps it at $500,000 — while California and other states exempt only what is “reasonably necessary” to support the owner and her dependents. Such wording is, inevitably, an invitation to lawsuits.

What is left unprotected is any money or investments (safe assets) outside of your retirement account, even money or safe assets in your living trust. Many people falsely believe that the living trust will protect assets from liability.  That is not true. They protect from probate, but not from creditors. If you have $50K in a brokerage account titled to your living trust and you are sued after getting in a car accident that your insurance does not cover, your $50K in the living trust is up for grabs. Why? Most living trusts are revocable, which means you may change them. If you can change them, a creditor can change them and take out your assets!

Keep in mind, your risk assets, like your business and real estate, should be held in different legal entities. Why? If you put your safe assets in the same entity as the risk assets and the risk asset entity is sued, that would jeopardize the safe assets. You want to keep separate risk and safe assets.

Which entity and state are best to protect your safe assets?

Typically, an LLC taxed as either a disregarded entity for tax purposes or an LLC taxed as a partnership is the best entity. The LLC has the charging order protection, making it more difficult for a creditor to get after your personal ownership in the LLC. Keep in mind, since it is a safe asset LLC, no one should be suing the LLC directly. That leads to our second point, which state is best? As you know, Nevada is a great state when it comes to protecting the entity veil (which comes into play when the entity is sued directly, and someone is attempting to go through the entity after the individual owner). But in this case, with a safe asset LLC, no one should be suing the operating entity, so Nevada is unnecessary. Your home state is just fine for a safe asset, LLC. Remember, an LLC is a flow-through entity when taxed as a partnership and disregarded entity. Therefore, there are no state tax advantages based on Nevada (most states do not have a state tax on pass-through LLCs; the exception is California).

Once the LLC is established, it is time to transfer your safe assets into the LLC as part of capitalization. If you have a brokerage account in your name, you will establish a new brokerage account in the name of the LLC and the new EIN and have the brokerage firm transfer over the account in the name of the new LLC. If you have cash in your personal account, you will write a check to the new LLC as part of capitalization.

How much value in safe assets do you need before you form a separate LLC?

That depends upon your unique situation, based upon how much you can afford to lose personally. If you have $40K in a brokerage account, 80% of your liquid assets, you may want to form a separate LLC to protect that safe asset. If you have $3K in investments in your own name, that is not something that would warrant a separate LLC to protect.