When you consult an attorney about estate planning, you trust that he or she is going to consider your goals and devise a plan to meet them. In general, most attorneys do. But as the saying goes, “You don’t know what you don’t know,” and it may not occur to you to tell your attorney that you want help with asset protection. Unfortunately, it also doesn’t occur to many attorneys to ask their clients about this critical issue. As a result, attorneys and clients focused on one goal, such as minimizing taxes or business succession planning, might make asset protection mistakes in estate planning. Let’s talk about some of the common mistakes, and how best to avoid them.
First off, let’s define “asset protection.” Asset protection is a type of financial planning intended to protect assets from creditors and keep them available for you or your intended beneficiaries. Some estate planning tools and techniques leave assets vulnerable to the claims of creditors, including divorcing spouses.
You may not have known to raise the issue of asset protection with your attorney, but he or she should raise it with you. Attorneys should discuss with clients the possibility of divorce or being sued, especially if the clients are in occupations at high risk of litigation, such as medicine or law (malpractice suits), business ownership, and real estate development. You may not have thought about these potential dangers—but your estate planning attorney should.
A charging order is essentially a lien on the interest of a judgment debtor which requires the LLC to pay the holder of the charging order any distribution the judgment debtor is supposed to receive. The primary purpose of a charging order is to protect the interests of the owners of an interest in LLCs (or limited partnerships) from the debts of the debtor-owner. A charging order entitles the holder to financial distributions, but not to voting powers in the business. For the best protection, use a multi-member LLC rather than a single-member LLC, which might be “pierced” (though Ohio law provides better protection for single-member LLCs than most other states.
A Domestic Asset Protection Trust is a self-settled irrevocable trust; the grantor (creator) of the trust may be a beneficiary of the trust. DAPTs are permitted by 18 states, including Ohio, which is consistently rated one of the best states for DAPTs. In Ohio, a creditor cannot “pierce” a DAPT except under very limited circumstances, such as if they are divorcing spouse or an individual or government agency involved in collecting alimony or child support.
Creditors may challenge a grantor’s transfer of assets into a DAPT. However, Ohio has the shortest statute of limitations (18 months) for creditors attempting such a challenge, which is an advantage for creators of an Ohio DAPT.
Staggered distribution trusts are common: for instance, they may call for distribution of a percentage of trust assets as beneficiaries reach certain ages. Grantors choose them because they offer a controlled release of assets as beneficiaries become more mature. Unfortunately, with such mandatory distributions (or if beneficiaries have a power to withdraw), creditors can gain access to the funds. A better choice is to have a distribution trustee with the power to make wholly discretionary distributions, or an independent trustee.
Dynasty trusts are irrevocable trusts which remain in trust for several generations, and are not subject to estate taxes for as long as permitted by state law. In addition to providing asset protection, dynasty trusts can also protect assets from a divorcing spouse.
So called “HEMS” trusts, which allow trustees to make distributions for a beneficiary’s health, education, maintenance, or support, may be able to be pierced by certain creditors, even if they contain a “spendthrift” provision designed for creditor protection. A better option is a discretionary trust, where distributions are entirely within the discretion of the trustee.
A third-party trust is one in which the grantor creates a trust for the beneficiaries other than him- or herself, say, for grandchildren. With a third-party discretionary trust, the trust is irrevocable, meaning the grantor cannot take the funds back, and distribution of funds is entirely within the trustee’s discretion.
From now until 2026, $11.4 million can be transferred without triggering gift tax. After 2026, this amount will be reduced. Transferring funds to a third-party discretionary trust now can mean not only significant tax savings, but excellent asset protection.
Certain classes of assets are exempt from creditor claims in Ohio: These include the homestead exemption of equity in a debtor’s personal residence; traditional and Roth IRAs; 529 and 529A Plans; and life insurance and most annuities. Don’t forget about these options.
ERISA offers protection from creditor claims to 100% of qualifying retirement assets. These include profit-sharing and pension plans. What’s more, this protection applies to claims from most creditors, with the exception of the Internal Revenue Service and divorcing spouses.
In Ohio, unlike most states, creditors must (with very limited exceptions) make proper presentment of their claims within six months of the death of the debtor. If they don’t do so, those claims are forever barred. In order to be properly presented, a claim must be made in writing to the court-appointed executor or administrator of the deceased’s estate.
If, however, the estate is not opened until after that six month period is over, the only option for a creditor to properly present a claim is to file it in probate court, effectively opening an estate itself. In practice, this is uncommon. What’s more, assets transferred outside of probate after the debtor has died are typically not reachable by creditors; only the probate estate is. So, by delaying the opening of an estate, assets may be protected from creditors.
If you have questions about Ohio asset protection, contact an experienced Ohio estate planning and probate attorney with experience in asset protection options.
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Thanks to Attorney Brian Layman for his extensive treatment of these issues in July/August 2019 issue of the Ohio Probate Law Journal, and the inspiration for this blog post.