At Paradigm Life, our concern is not limited to how you earn, use, borrow and grow your money—we are also concerned with how you protect your money. In fact, we recognize and stress the importance of protecting ALL of your assets. To achieve this level of maximum protection, we highly encourage our clients to create and implement a complete Estate Plan with the assistance of a competent and knowledgeable attorney in this field. Without this asset protection, even the “best” estate and financial plan can be rendered useless.
There are many ways to protect your assets, and you can start by looking at State and Federal Statutes and then take “action” by creating LLCs, Asset Protection Trusts, Insurance and other asset protection vehicles.
Besides having protection from lawsuits and carrying sufficient insurance, your personal asset protection has two main principal components:
1) Identifying and Maximizing your Exempt Assets, such as Homestead Exemptions, Qualified Retirement Plans, Life Insurance, Annuities and more.
2) Transferring your Non-Exempt Assets to Asset Protection Vehicles. Non-Exempt Assets are usually cash, stocks, other investments, second cars or homes.
In this article, we will only focus on maximizing Life Insurance and Annuities.
The use of cash value life insurance as a wealth building and asset protection tool has always been very popular. This is primarily due to the fact that once funded, the money can grow tax-free and can be removed tax-free in retirement without any 59 ½ age restrictions or penalties. Life insurance provides a guaranteed death benefit, and in some states enjoys uniquely preferential treatment under the Internal Revenue Code:
* All earnings accumulate free of taxes until withdrawal.
* The death benefit can pass to beneficiaries tax-free.
* Tax-free loans.
* Tax-free exchanges are possible.
Although life insurance and annuity contracts receive only minimal protection under the federal bankruptcy laws in most states, the laws exempt annuities and life insurance policies from some or all creditor claims. In many states, life insurance is protected against debtors of the insured and the insured’s spouse or dependents, to an unlimited dollar amount. Although almost every state protects the death benefit of an insurance policy from creditors where a spouse or child is the beneficiary, the policy’s cash value may not be exempt in some states or it may have a limit on the amount of the protection.
The better asset protection states will protect the owner’s cash value as well as the beneficiary’s death benefit. The worst states may not protect the life insurance at all, or only the proceeds paid to beneficiaries when the insured dies. However, total asset protection can be accomplished through the use of a Trust or an LLC.
One of the reasons it is difficult for a creditor to access life insurance and annuity policies is because when you purchase them you are contractually taking back the promise of future payments in exchange for your premiums today.
As you can see, the asset/creditor protection for life insurance is complicated and must always be researched as to the specific facts involved in each case.
An annuity is a contract where an insurance company, or other guarantor, agrees that in exchange for a single premium, or series of premiums, they will make a series of payments to someone for the rest of their life or joint lives (e.g., husband and wife) for a fixed number of years. The income earned within an annuity is tax deferred until you cash in the contract or receive payments from it.
The income component of the payments is subject to ordinary income tax. A 10% federal penalty tax applies to most annuity withdrawals before you reach age 59-1/2. Annuities are typically purchased for guaranteed income during one’s lifetime, rather than to pass assets to their heirs. There are many variables on how the income can be paid with the addition of riders, but for our purposes I will stay with the basic annuity use and asset protection.
In most states, for an annuity to be protected the payments must be payable to someone other than the contract owner.
When should I start?
There is a Chinese Proverb that says “The best time to plant a tree was 20 years ago, the second best time is now.” Like any strategy that includes an asset protection component, timing is of the essence. In most states, clients who have an existing lawsuit or other immediate creditor exposure cannot usually make an 11th hour move into life insurance and claim safety, so you want to start your asset protection/estate planning strategy as soon as possible.
Life insurance also requires an insurable individual for the policy to be written on. In many cases, the spouses of most income earners are underinsured, are often healthier and may have a lower chance of being sued, so don’t overlook using a spouse instead of, or in addition to, the primary insured or income earner.
While this information merely scratches the surface of using life insurance or an annuity in an asset protection/creditor protection plan, hopefully, it sheds a little light on how you may benefit from using the right vehicles to create a stable, liquid cash alternative in a difficult or threatening economic marketplace.
I am not an attorney and this article is not meant as legal advice. It is an overview and a starting point for your research.
Because there are many variables between state-to-state laws, please find the following links to various resources for state specific protections. These sites are updated frequently, but because of a changing legal field and individual situations I highly recommend seeking legal counsel for your specific state and situation.