Selling life insurance today is not nearly as simple as it used to be.  Today there are many different types of life policies (whole, variable, universal, indexed universal, no-cash value universal, term, return of premium term, etc.).  Today there are so many features with the policies as well (variable or fixed loans, long-term care and critical- illness riders, high-cash value, springing-cash value, etc.).

Most advisors who sell life insurance think they know the basics of what they are selling to provide the best product to their clients so they don’t get sued for putting a client in the wrong product or one they don’t understand.   Unfortunately, that is not always the case.

Expenses in indexed life insurance policies

Do you know the expenses in an indexed equity life insurance policy and how they change when a client reduces the death benefit (face amount) of the policy within the first 10 years? (This e-mail will only discuss equity-indexed life insurance as that is where I’ve done my research).

When I talk about costs in a policy, I want to discuss the “costs of insurance” and the “per 1000” charges.

The costs of insurance are just that. If a client purchased a policy with a $2,000,000 death benefit, the insurance costs were based on the costs of $2,000,000 of insurance.  If a client had to reduce the death benefit to say $1,000,000 for whatever reasons (like not having the money to pay the premium), the costs of insurance would be lowered accordingly (which makes sense).

I like to define the “per 1000” charges as the “other” costs that an insurance company charges the client annually in the policy.  These costs are not insignificant.

The dirty little secret

Did you know that almost every indexed equity life policy in the marketplace has a quirk to their policies which you won’t believe and which can have catastrophic consequences when things don’t go as planned for your clients?

What quirk?  When a client needs to or is forced to reduce the premiums paid into a cash-building life insurance policy and, in turn, lowers the death benefit to reduce costs in an attempt to build the most cash in the policy, the insurance companies DO NOT lower their per 1000 charges.

It sounds harmless, but it’s not.  If a client budgets $10,000 to be paid into a cash-building indexed equity life insurance policy and does so until he/she gets disabled or is fired from his/her job, what is the client going to do with the life insurance policy?  The client will stop paying premiums because of a reduction or loss of income.  The life insurance premium will be one of the first expenses not paid while the mortgage, car, and utility payments are made (hopefully).

Let’s assume the client budgeted to pay $10,000 into the policy for 10 years and then gets disabled or loses his/her job in year three. Let’s assume the client will no longer be able to make premium payments into the policy or if premiums are paid they will be more like $1,000 a year.

What do you tell the client? Sorry, your policy will explode in the next few years and the $30,000 in premiums will evaporate?   Probably not. You’ll probably tell the client to lower the death benefit down to the lowest point possible after budgeting what if any, future premiums will be paid into the policy.  The theory is that, if the death benefit is lowered, the expenses will be lowered and the policy will still build cash and certainly won’t lapse.

What’s the problem with this thinking?  The costs of insurance will be lowered when the death benefit is lowered, but the per 1000 charges WILL NOT.  If in the above example, the client started with a $400,000 death benefit and lowered it down to say $100,000, the “costs of insurance” would be lowered to the costs for $100,000 of coverage, but the “per 1000” charges will be charged as if the client still had $400,000 coverage.

The end result will be that in a few years after the client lowers the death benefit and reduces or stops paying premiums, he/she will likely receive a letter from the insurance company telling him/her that the policy is going to lapse unless more premiums are paid.

Why do companies not lower the per 1000 charges?

I’ve been told the reasons have to do with the costs incurred by the insurance company in the early years after issuing a policy which must be recouped regardless of whether a client lowers the death benefit or not.  What costs?  Little costs like insurance agent commissions (which are usually paid up front) and taxes the insurance company pays which are based on the initial death benefit at issue.

Usually, the insurance companies spread these costs over the first 10-15 years; and if a client lowers the death benefit after that time frame, then the per 1000 charges will be lowered.

Do all equity-indexed policies have this problem?

No. When I learned of this per 1000 charge problem several years ago, I looked high and low for a policy that was more client-friendly.  I am sending this newsletter to inform readers about the new Revolutionary Life policy.  I’m proud to say that the policy has a rider thanks to my insistence (with little cost) where the client can choose to have the per 1000 charges lowered in the event the death benefit is lowered in the first 10 years.

Why am I discussing this today?

First and foremost, I wanted to put everyone on notice of the problem and the fact that there are client friendly policies in the marketplace you might want to look into.

Also, as you know, I’ve been discussing what’s wrong with the Missed Fortune 101 approach lately.  One problem with the Missed Fortune 101 sale is that the concept is being sold to those who are financially unstable.  Clients are being told life insurance is the “safest” investment (and it can be if funded as illustrated) to reposition equity stripped out of their personal residences.  That is false and misleading and can get an advisor sued.

What if a client removes $100,000 of equity from their home and repositions it in an indexed equity life insurance policy that does not lower its per 1000 charges in the event the client needs to lower the death benefit?  What if the client who has been told he/she can access the policy’s cash in a time of need and tries to do so in the first ten years of a typical policy (because of losing their job or a disability or even divorce)?

If a client doesn’t fund the policy as planned and needs to access cash in the first ten years, the client is in for a real surprise. When the client borrows money from the policy, the death benefit will be reduced; but the per 1000 charges will NOT be.  This will ultimately be the demise of the life policy if the client does not get back on his/her feet soon and is able to pay more premiums into the policy.

This scenario will make a client upset and could potentially be a lawsuit waiting to happen for the life insurance agent.

This situation could be avoided by offering the client a policy where the per 1000 charges will be lowered in the event the client is forced to stop paying premiums into the policy for financial or other reasons.

Summary

It’s important to know not only what the insurance companies want you to know about their products but also things they seem to not want you to know (or at least do not go out of their way to make you aware of).     Real life gets in the way of our client’s good intentions to fund cash value policies for wealth building; and when that happens, it is our duty to inform them how to protect themselves from adverse financial consequences.  Fully informing clients on these issues is good business and a good way to help advisors avoid E&O claims.

Roccy DeFrancesco, JD, CAPP, CMP

Are you a CAPP or MMB?  To learn more about the CAPP, or MMB certification courses and how to take your consulting to the “next level” go to www.thewpi.org.

This week is a reverent occasion for the American family. We celebrate unity by putting family differences aside, and enjoying sports, movies, and of course, good food! Often the legacies of our families are portrayed to future generations only with the pictures at the dinner table while we sit around and enjoy the holiday. This travels to the heart of estate planning and to the reason that drives so many of us to strive for excellence in all of our endeavors.

Do I need an estate plan?

Certainly, it is not a crime to die without an estate plan, but if you do not employ a method of transferring your assets, you will die intestate, which means the state probate court will determine your Last Will & Testament according to decree of law (probate). In essence, you have a choice. You can let the state decide the outcome of your assets, or you can decide the outcome of your assets.

What is an estate plan?

An estate plan is the documentation by which an owner of an asset chooses one or more legal methods of transferring all of his or her assets to chosen recipients upon death. A proper estate plan takes into account personal, administrative, and transfer tax matters in order to create the most efficient, cost-effective means of transferring a particular estate upon the owner’s death.

You have five choices: 1) Do nothing and go to probate, 2) Use Jointly Owned Property protection 3) Create a Will or 4) Create a Trust, 5) Use another method of transfer, such as a Family Limited Partnership, or a combination of all the above.

What is wrong with probate?

First of all, the court has to decide the legal decedent. Secondly, probate takes months and costs the estate money. Probate is a record of public file and all family matters pertaining to inheritance become the records of the courts. The other aspect of probate is the fact that estate taxes would likely have been mitigated if the legal options available had been enacted. Since a deceased person is unable to transfer their assets, in the interest of the public, a court will transfer the assets from its’ neutral perspective according to the law.

There are also many laborious and costly steps in probate even with a Last Will & Testament when a person dies with a will (testate) that can be avoided by employing legal methods afforded to all persons with assets.

How can I avoid probate?

There are many options. One very common way is to hold property as join-tenants-with-rights-of-survivorship (JTWROS). Another method is by deeding realty property to someone with a life estate retention clause in the deed.  A third well-known strategy of avoiding probate of bank accounts, life insurance, IRAs, and other assets normally held in accounts is to make those accounts payable on death (POD) directly to a named beneficiary.  All of these methods, however, can create potentially undesirable outcomes ranging from loss of control and unnecessary lawsuit exposure during a lifetime to the forfeiture of a thoughtfully structured disposition of one’s estate at death.

The real reason for this newsletter!

The best alternative and the core foundation of estate planning is the Revocable Living Trust (RLT). When the creator of a living trust transfers assets to the trust, actually to himself as the trustee, he has already conveyed legal title to his assets to a “party” that does not cease to exist when he dies.  That party is the office of the trustee, which he may occupy during his lifetime.  Specific assets of the estate determine the particulars and the other methods that may be available to use in conjunction with an RLT. Irrevocable trusts, family-limited partnerships, and charitable trusts are also options.

When the living trust transfers the assets to the trust, the conveyance has already occurred; it occurs while a person is living rather than upon their death.

It is worth mentioning that there are many offshore methods that provide superiority to domestic Asset Protection.

Discussing this within families is a difficult task. There is no great time to discuss the subject and the holidays certainly fall into this category. What our holiday traditions remind us of is that our family legacies are worth protecting. Conventional wisdom tells us that at some point we must discuss this.

As Asset Protection practitioners, we encourage you to think about an estate plan in the future if you do not already have one. Though the holidays are not great times for these discussions, they are the times to observe our gratitude and reflect on what role family legacy can play in future generations.

The IRS recently issued Notice 2008-34 to prevent the shifting of a built-in loss from a tax-indifferent party to a U.S. taxpayer that has not incurred the economic loss.  IRS Notice 2008-34 names DAT transactions as a listed transaction warning taxpayers and anyone involved with the transactions that fines may be imposed for their involvement.

In the past, before October 23, 2004, taxpayers used partnerships to improperly engage in the DAT variations listed below.  “The American Jobs Creation Act of 2004, Public Law 108-357 (118 Stat. 1418) (AJCA), amended §§ 704, 734 and 743 effective after October 22, 2004, for contributions of built-in loss property to a partnership, for basis adjustment rules in the case of a distribution for which there is a substantial basis reduction, and for basis adjustment rules in the case of a transfer of a partnership interest for which there is a substantial built-in loss. The revisions to §§ 704, 734, and 743 generally (1) require that a built-in loss may be taken into account only by the contributing partner and not other partners, and (2) make the basis adjustment rules mandatory in cases with a substantial basis reduction or substantial built-in loss.” See IRS Notice 2008-34, www.irs.gov/irb/2008-12_IRB/ar.12.html

IRS Notice 2008-34 is now warning that using the DAT transaction to circumvent the American Jobs Creation Act is a listed transaction; the APS through its founders and members are warning you as an advisor and/or client to stay away from this type of transaction.

Jarrett T. Bostwick, J.D., LL.M., and Gabriel G. Tsui, C.P.A., J.D.

How did it all begin?

Trusts were first derived under the Statute of Uses in England in 1535. Prior to 1535, the legal real property practice was for landlords (landholders) to pay a type of land-royalty fee to the King. As you may know, land in England was fundamentally owned by the King and landlords could buy leaseholds from the King in his capacity of freeholder. These leaseholds could span a period of years exceeding 99 years. Oddly, the real property laws of England and many of its then colonies still use this land ownership of freehold and leasehold. Under King Henry VIII’s reign, these payments were exacted from landholders and upon the death of a landholder the King could exact additional fees, like an inheritance tax, from the heir. Landholders began transferring their leaseholds into the name of one individual but for the benefit of another. This transactional party above would be termed the cestui que use and become the person benefiting from the use of the land but was neither the initial landholder nor the heir of the landholder.

Under this plan, there arose a type of land ownership termed “use”. This idea caught on quickly across the English countryside and it was not long before the courts of England recognized this use right allowing the landholder to transfer possession of the land to one individual for use of the land while transferring legal title to another. Transferring title to land to two or more individuals, the landholder was also able to avoid other fees such as marriage fees and other fees associated with the death of a landholder. If the property was held in other persons’ names, a landholder could also avoid losing the property due to debt or felony conviction. By the end of the fifteenth century, almost all of the land in England was owned in use.

Like any government that is dependent upon revenue generation to run its country, England was no different. The King, King Henry VIII at that time, was a very determined monarch and personally pushed through Parliament a special law designed to stop this loss of money for the Realm. This law was termed the Statute of Uses. This legislation terminated the short historic bifurcating of land rights between use and title, as I noted above. This legislation also acted to transfer full title to land automatically to the individual that was using the land as well as a reinstatement of the draconian feudal rule of primogeniture, which held that land should go to the oldest son upon the death of the landowner. Predictable, landholders vigorously abhorred this legislation, and after a protracted and focused lobbying by the landholders the King scrapped the legislation. However, just five years later, Parliament enacted the Statute of Wills which gave rights to the landholders to pass property at their own discretion in the form of a written will and testament. Parliament did not rescind the Statute of Uses. Now not only were the landholders appalled but the courts were equally enraged.

Somewhat similar to modern circumstances, landholders began a period of creativity by finding and exploring loopholes in the legislation and the court also responded by using strict construction of the unfavorable legislation by allowing landholders to place the property in the title of another individual while simultaneously retaining use of the property for their own use, benefit, and profit. It was ultimately the courts that expanded this practice of the landholders into a concept of trust whereby a vehicle labeled a land trust allowed one individual to hold title to the land for the benefit of another individual who may direct the management and use of the land. The courts went on to reason that a trust allows the landholder to have some ability to use the land and that the person who received the transfer of the land performed no labor on the land and had no real function to the land, except to hold title. Thus, this individual became known as the “trustee”. The courts further reasoned that the trust was recognized in the courts of equity, but not in the courts of law. Thus, trusts had no jural ability to be sued or to sue in courts of law. This notion still exists in England as well as the United States.

From 1535 to 2010

This equity v. legal fiction above has a presence in today’s world. Traditionally, a litigant cannot file against a trust because the trust lacks any legal recognition in courts of law. This non-existent legal entity status causes the litigant to bring a claim against the trust indirectly by suing the trustee under the trustee’s personal capacity. The trustee may seek some type of reimbursement from the trust after the litigation is concluded for fees and costs and hope the trust will have sufficient assets to meet these reimbursements. Currently, all states of the United States via legislation, with the exception of Mississippi and West Virginia, have modified this traditional law by adopting either the Uniform Trust Code or the Uniform Probate Code, or similar statutes, separating the trust entity from the trustee, severing the liability of the trust from the liability of the trustee, and allowing suit against the trustee in its representative capacity as opposed to its personal capacity.

Modern trust law evolves from state legislation and state case law and allows an individual to protect much more than land ownership and land use. These recent Domestic Asset Protection Trusts, DAPT, are trusts that protect a variety of real and personal, tangible and intangible, assets from creditors, some states also include as a future spouse. APT allows the individuals establishing the trust and funding the trust, the settler, to include themselves as a possible beneficiary of the trust; which trusts are also called “self-settled trusts”. DAPT is an excellent estate planning instrument that should not be overlooked, a viable form of real asset protection to shield against attacks of the settler’s future spouse and other creditors with the provision that the DAPT does not violate a particular state’s fraudulent transfer laws. DAPT would have had significant use for our current adultery-minded mega movie and sports stars. DAPT requires no disclosure of the trust structure and no disclosure of what assets a replaced within the trust.

If, for example, a mega-star sets up a DAPT in one of the states that permits this type of DAPT before marriage, upon a dissolution of marriage the assets are protected from then on – the adulterer spouse and lesser income earning spouse will not be a part of an equitable distribution. Therefore, public knowledge of these assets is not revealed in court records, and the outcome will be significantly better than an antenuptial agreement which may be public and may ultimately fail in a divorce proceeding.

DAPTs are utilized by individuals, entities, and families as an inherent part of their financial, income, and asset lifetime perpetual efforts to bring about a diminishment of fear, uncertainty, and doubt over the professional management and preservation of these three types of assets during your life, while assets are in probate or administrations and after death, probate or administration. These fear factors exist with us in our everyday lives. According to the Enrichment Journal on the divorce rates in America, the divorce rate in America for a first marriage is 41%; the divorce rate in America for a second marriage is 60%; the divorce rate in America for a third marriage is 73%.

CONCLUSION:

While DAPTs have their place in traditional estate and asset protection planning, they are certainly not the end-all to be all. They can be an instrumental tool in a planner’s toolbox. As Tim Berry pointed out in his most recent article America and Americans are the most litigious society on the planet and anything can happen at any time. Just a simple innocent act can cause injury or damage which can find its way into our court system and from there, a claim against you with subsequent interrogatories asking intrusive personal questions to the plaintiff and the plaintiff’s attorney can determine how deep your financial pockets are. Proper and legal DAPT planning can help to protect personal assets from legal threats, including threats arising from business, professional, and commercial activities; regulatory liability; and personal and family activities. DAPT planning is also necessary even when you have insurance; given the policy’s narrow coverage scope, exclusions, exceedingly small coverage, premiums increasing each year, insurance companies dropping you without any warning or known reason, and insurance carriers going bankrupt.

This is part one of a series on DAPTs. My next article will focus on trustee liability and how to best limit this real financial and legal threat for trustees, financial planners, attorneys, C.P.A.s, and, of course, their clients.

However, only recently did any real advancement occur for domestic protection. Probably the first real effort at legislating domestic asset protection was by the state of Alaska. On April 1, 1997, Alaska’s then Governor Tony Knowles signed House Bill 101 into his state’s law. The purpose of Bill 101 was Alaska’s legislature effort to create a type of state stimulus package as well as to designate Alaska as a global player for asset protection. Bill 101 had four primary objectives: (i) to legally provide for the establishment of self-settled spendthrift trusts in Alaska; (ii) to create a legal atmosphere wherein to establish the choice of law provision, thus selecting Alaska law to govern a trust; (iii) to establish timing considerations as limits on fraudulent transfer actions which would enhance the then debtor-friendly fraudulent transfer laws and; (iv) to replace the statutory rule against perpetuities for trusts which would allow unlimited life for an Alaskan trust.

ALASKA TRUST LEGISLATION
Bill 101 led the American legislative path contrary to the well-established 1487 English statute prohibiting self-settled spendthrift trusts, “[a]ll deeds of gift of goods and chattels, made or to be made in trust to the use of that person or persons that made the same deed or gift, be void and of none effect.” This 1487 statute is not dependent on the Settlor’s intent or lack of intent to defraud creditors currently or in the future, while other’s jurisdictions’ current Fraudulent Transfer laws focus heavily on the Settlor’s intent to defraud known or future creditors. Alaska’s self-settled spendthrift (discretionary) trust provides that the Settlor shall be the discretionary beneficiary of the trust that contains a spendthrift provision, one which prohibits the beneficiary’s creditors from reaching the trust assets, even though such assets could be discretionarily distributed to the Settlor. This Alaskan legislation was totally against public policy and, therefore, mitigating language was drafted into its legislation.

Even with the above legislative intent on Fraudulent Transfers, a creditor can attack the trust and reach trust assets in four exceptions:

1. The transfer was intended in whole or in part to hinder, delay, or defraud creditors or other defined persons.
2. The trust provides that the Settlor may revoke or terminate all or part of the trust.
3. The trust requires that all or a part of the trust’s income or principal, or both, must be distributed to the Settlor, or
4. At the time of the transfer, the Settlor was in default by 30 or more days of making a payment due under a child support judgment or order.

To offset those above exceptions’ allowance, Alaska’s new statute of limitations provides that a person who is a creditor when the trust is created may not bring an action with respect to a claim unless the action is brought within the later of (i) four years after the transfer to the trust is made, or (ii) one year after the transfer to the trust is, or reasonably could have been, discovered by the creditor. If the person became a creditor subsequent to the transfer of the trust, the action must be brought within four years after the transfer is made.

It is important to note that there are severe restrictions on the Settlor in retaining any interest in the trust. The trust must be created as an irrevocable trust, which means the Settlor must not possess any domain or control over the trust or trust property. Creditors will then only be able to stand in the shoes of the Settlor when or if the Trustee independently determines it is in the best interest of the Trust to distribute property to the Beneficiary. The Creditors can then push the Beneficiary away from that property distribution stream and claim that distribution as applied against the outstanding debt of the Settlor/Beneficiary.

MORE STATES ENACT DAPT LEGISLATION
It was not long after the successful implementation of the Alaska Trust Act that other states entered this trust arena. Later in the same year, 1997, Delaware adopted its legislation titled, “Delaware Qualified Dispositions in Trust Act.” Delaware continues to be instrumental in amending the initial Act in their State’s efforts to be the leader in DAPT. In addition to Alaska and Delaware, six more states are in the legislative enactment of DAPT laws and replacing the well-established English common law of the Rule Against Self-Settled Trusts.

At the date of this article, there are thirteen states legislatively utilizing DAPT: Alaska (1997), Colorado (1997), Delaware (1997), Nevada (1999), Rhode Island (1999), Utah (2004), Oklahoma (2004), Missouri (2004), and, effective July 1, 2005, the state of South Dakota. Additionally, other states have enacted legislation for DAPT, including as of this writing: Wyoming Qualified Spendthrift Trust Legislation On February 28, 2007, Tennessee’s Investment Services Act and Enhances Asset Protection of July 3, 2007, New Hampshire “Qualified Dispositions in Trust Act” January 1, 2009 and Hawaii’s Permitted Transfer In Trust Act July 1, 2010. Although all thirteen states are in concert with the legislative replacement of the public policy against self-settled trusts, these states’ jurisdictions provide for a self-settled trust to be entitled to the legal allowance of what was only in the past granted to a non self-settled spendthrift trust, the avoidance of attack from creditors if there was no intent to defraud creditors as discussed above.

Do not be confused of the belief that even though these eleven states have a common focus that the statutory language is therefore the same. Delaware seems the most active in changing its legislation to keep in front of other states’ legislative attraction to new trust formations within their jurisdictions. The state of Oklahoma statute has a one million dollar “cap” as to the value that can be protected under its legislated self-settled trust. The eleven states also differ in matters of limitations on the Statute of Limitations as it applies to fraudulent transfer rules that vary between 2 and 4 years. The character of assets that can be protected from within the trust will vary between DAPT states. Even the physical and legal location of assets within the trusts can vary between DAPT states.

SECRECY AND CONFIDENTIALITY
Some states attempt to compete with OAPT in matters of secrecy and confidentiality. Alaska attempted to adopt strong “secrecy” provisions into its trust legislation in an effort to protect the confidential nature of the trust and any related information, including the identity of the beneficiaries of the trust and the assets of the trust. It is important to note that this type of legislation has limits within the DAPT framework. This state legislation may be successful against the premature disclosure of information relating to the trust while litigation is pending. However, this information will be discoverable in a post-judgment situation and most certainly discoverable by state and federal authorities. Even so, other states including Nevada have extended the right of privacy to the corporate world by providing that the officers and directors of a DAPT state’s based company can be “nominees,” persons who are disclosed as having and exercising their legal capacity for the company when in fact they are acting on behalf of undisclosed principals. As an example, Nevada’s legislation allows an individual to serve as an officer, manager, or director of a Nevada company without having his or her name disclosed on public documents such as contracts or other documents that might be entered as part of a business transaction or that might actually be even available in the public records. With the searching abilities on the internet, this secrecy provision may be preliminarily quite valuable when a potential litigant’s legal counsel determines financial worth of a possible defendant.

RETENTION OF POWERS
Some state’s statutes allow the Settlor to actually retain critical and salient powers: (i) to veto distributions, (ii) to appoint advisors, (iii) to appoint trust protectors to the trust, (iv) the retention of the power to direct investments, and (v) the appointment of investment advisors to the trust. A few states provide the power to allow the Settlor to remove and replace the Trustee. All of the abovementioned powers given via legislation to the Settlor are for the domain and control over the DAPT. If the Settlor had wanted such domain and control over an OAPT, then potential litigants would have a hugely significant advantage over the OAPT in which the litigant could obtain a judgment in the OAPT jurisdiction for payment of debts, obligations and judgments. As a word of caution, these states’ legislation with retention of powers clauses should be viewed with great trepidation since the oldest DAPT legislation is only 13 years old and not properly tested under a series of court cases, Federal or State, which would then give a more reasonable reliance on these retained powers that would normally destroy a person’s trust planning structure. There still needs to be more cases in which the trust is established in one of the DAPT jurisdictions and the trust assets in another jurisdiction, in which case, the center question is whether the asset location state will honor the DAPT legislation in place of its own laws.

REDOMICILE POWERS:
Some states have gone the extra mile in trying to anticipate the Settlor’s wish of having the ability, legislatively, to redomicile the state trust to a foreign jurisdiction as an OAPT. This provision was enacted with the intent of the particular state’s legislators to ease the uncertainty over the total effectiveness of the DAPT functions and protections within the United States and internationally. Official state law allowing sanctioned offshore redomiciliations, wherein the Trustee may remove the trust and trust assets from potential litigation, is a massive win by the Settlor. The Settlor’s act of removal and redomiciliation is actually legally provided by under state law and, therefore, outside of any claimed civil liability to the Trustee.

CONCLUSION
Eleven states, as of this writing, have enacted variations of Domestic Asset Protection Trusts with each state claiming superiority over the other. The common threads that run between these state enactments are continued employment and revenue generation within the state. Most of these states are of sparse population or insufficient revenue collection. However, they do offer a choice somewhere between merely putting assets in all or part of another individual’s name such as tenancy in common or joint tenancy to the Offshore Trust jurisdictions. Before embarking on establishing a particular DAPT and the complexity and expense of transferring assets, it is best that you consult with an experienced and knowledgeable advisor, preferably with practical knowledge of how these DAPT entities will withstand the rigors of vigorous litigation. You may also seek to know whether these DAPT are capable of providing your particular level of protection for your particular assets and if, when under attack from a litigant, you have further options such as transmuting Trust assets to an OAPT without fatally losing your protected assets.

Americans are an interesting people with understandably mixed feeling of watching their lifetime of hard-earned assets leaving the shores of the United States. Still, they are filled with concern over the U.S. government’s positions that may decrease the value of the U.S. dollar, propose new legislation against transferring money and property overseas, and allow even more intrusion into a person’s privacy. My next article of this series will focus on Offshore Asset Protection Trusts and the initial procedure to determine their value and use for an individual’s benefit. I may write one additional article if it seems that the readers express a desire for additional information to fill any unintended gaps that were not addressed in the four articles.

If you have any questions, give us a call or email us so we can discuss your particular situation.

Michael B. Nelson, Esq.

Market Goes Up and Down like a Yo-Yo?

When reading this newsletter don’t forget that anyone or anything that can take your or your client’s money is a creditor. That includes the stock market.

I don’t know about you, but I’m a bit freaked out about the stock market. I know I’m relatively young, have a lot of time to recover, and don’t have a million dollars in the market, but it’s very uneasy to think about the security of my invested assets in such a volatile market.

The day that I wrote this the S&P 500 index went up and down nearly 10%. To say that is volatile is an understatement.

You know what everyone says:  If you are in the market for the “long-term” you don’t have to worry about the short-term losses.

I guess that sort of makes sense, doesn’t it? Or does it?

This is a new very volatile world and I wrote this newsletter to give you something to think about and determine if “buying and holding” stocks right now is a good idea even when looking at the long term.

Ask yourself this question: If the stock market goes up and down and up and down over a ten year period with the average rate of return equaling ZERO, will the account balance be the same at the end of the ten-year period?

Put another way, if you invested $100,000 in the S&P 500 index where the index went up 10% the first year, then down 10%, then up 10%, then down 10%, and if this cycle continued for 10 years with the average rate of return equaling ZERO, would your initial investment still be $100,000?

The answer is NO!

Look at the following chart where I assumed a very volatile market that goes up and down 10% every year and after ten years the average return is ZERO.  You’ll notice that the account value is $95,438.

Never go backward and lock in gains

Most of you know that I’m a big fan of Fixed Indexed Annuities (FIAs) to hedge a client’s risk in the market and to earn decent returns when the stock market does well.  FIAs are not a cure-all, not every penny of someone’s money should be in them, but as an asset allocation model, the older you get the more money you should have in a wealth-building tool that will not go backward.

If you are not familiar with FIAs, please click here to view a brief voiced-over educational PowerPoint Presentation.

What if the $100,000 invested in the above example instead went into FIAs?  If I make a very conservative assumption that over time the cap on returns will be 8% annually, look at the results.

Why did the FIA end up with an account balance of $146,933 instead of $95,099?  Simple, in down years the FIA returned zero instead of -10% and in up years it returned 8%.
Are these examples the real world?  Before 1998 you would have said no way?  Are these examples the real world?  Who knows, they could be. The question of the day is: are you doing everything you can to help educate and protect your client’s money in this uncertain world?  Recently, I wrote an article titled Should Clients Sue Money Managers When the Stock Market Collapses?, to read that article, please, click here.  I mention that article because, as this article does, I am attempting to stress the importance of fiduciary duty and the standard of care that you are held to when dealing with your clients and their assets.
It’s one thing to be upset when you only earned 8% when the market is up 10%+, it’s another and much more positive feeling when your money earns ZERO when the market is down 10%.  The first feeling makes you a little grumpy, but the second, even though it sounds odd to be happy with a ZERO rate of return, brings a nice smile to your face (especially if you are over the age of 60-65 and close to or in retirement).
-20%

Just in case you are curious, if the market has wild swings of 20% every other year (up and down), the account balance at the end of 10 years would be $81,537 and the FIA account balance would remain at $146,933.
Conclusion

I’m not sure if the days of “buy and hold” have come and gone as a tried and true way of growing your wealth. That may or may not be the case. What I know is that it’s time to have a discussion with your clients to help them understand ALL the various options to grow and protect their wealth and I think that conversation should include the information discussed in this newsletter.

Roccy DeFrancesco, CAPP, CMP

What is “personal” asset protection?

It’s when someone takes steps to protect “all” of their valuable assets from creditors.

What assets should be protected? The major ones are:

-Personal residence (which is the most difficult asset to protect)
-Brokerage accounts
-Vacation properties
-Business interests (such as S- or C-Corporation stock or a Limited Liability Company)

Why do people need “personal” asset protection?

To protect from negligence lawsuits such as your garden variety car accident.

You may have heard the statistic that texting and driving is six times more dangerous than drinking and driving. Even so, millions of Americans text and drive multiple times a day. There are few people you’ll run into who, if they are being truthful, won’t admit to that oh my gosh moment where they look up from texting only to see a bike rider they almost ran over or the fact they swerved into oncoming traffic or even just ran a red light or a stop sign.

This article wasn’t written to judge people, it was written to help advisors who give them advice make sure they are aware of the best entity selection for businesses as it relates to “personal” asset protection.

Limited Liability Companies (LLCs) are “the” entity for personal asset protection

Let me get off the board two entities that should never be used to run a business (they aren’t even entities). They are sole proprietorships and true partnerships. Neither provides personal asset protection or limited liability from business activities.

Let’s now examine the asset protection features of S- and C-Corporations.

Both entities protect a business owner’s personal assets from the liability of the business itself. For example, if the business put out a defective product that caused harm, the business owner’s personal brokerage account or vacation property would not be at risk. The exception to this is piercing the corporate veil which is rare and outside the scope of this article.

But what if the business owner is driving to dinner, texts someone while on his/her phone, causes a car crash, and is sued for negligent driving?

What can the creditor go after?

All the business owner’s assets which include S- or C-Corporation stock.

How did the S- or C-Corporation work from a personal asset protection point of view? Not well.

What about an LLC?

If the LLC is set up properly, using the same car crash example, the creditor is NOT going to be able to go after the business owner’s interest in the LLC.

What makes LLCs so special when it comes to personal asset protection? It’s the remedy a court can fashion when a creditor tries to go after the asset.

With an S- or C-Corporation, the creditor could ask the judge to force a sale of stock to satisfy the judgment or force the profits of the corporation to go to the creditor.

With a properly set up LLC, a judge will NOT be able to force the sale of the business owner’s interest or force distributions that would go to the creditor.

With a properly set up LLC, a judge will only be able to give the creditor what is known as a “Charging Order” which essentially gives the creditor nothing but the ability to sit around and wait for a distribution that may never come. The business can continue as normal and pay the business owner a salary, fund his/her pension, etc.

What do I mean when I say the LLC needs to be set up correctly?

Not every state’s LLC statute has what I call the magic language. That language would say something like the following: the “sole remedy” a creditor can receive when going after someone’s interest in an LLC is a Charging Order.

Additionally, the LLC needs to be multi-member. Single-member LLCs while simple and cheap have been seen by some courts as a legal fiction and set aside for asset protection purposes.

What if your state doesn’t have the magic language in its LLC statute? No problem, you just form it in one of the states that do and then have it filed to do business in your state.

What states have the magic language?

There are more and more each year as other states have gotten tired of losing fee revenue to states that do offer it. States like Nevada, Delaware, Arizona, Michigan, and many more.

But what about entity selection for tax purposes?

The unique thing about an LLC is that it can be taxed as a partnership, S-, or C-Corporation. You just have to file the appropriate forms to make it so.

Summary

While taxes may be the primary focus for CPAs who help clients with entity selection, it’s just one element that needs to be considered. A second element that needs to be considered when helping clients with entity selection is asset protection. Arguably, asset protection even more important element to consider. If you choose to add asset protection as an element in your entity selection process, a multi-member LLC set up in the correct state should be the entity of choice.

Most “experts” will tell you that if you own a property as tenants by the entireties, the property can’t be used to satisfy the debts of just one of the owners. Well, that isn’t true and I’ve got the deed on the property to prove it.

The reason for the article today is that I’m about to bust another asset protection myth; I’m going to purchase a bankruptcy debtor’s interest in a spendthrift-protected trust.

Once again, if you talk to most “experts” they are going to tell you that if a trust has something called “spendthrift” protection, then the trust is protected and the beneficial interest can’t be yanked away from the beneficiary. In general, that is a true statement. The bankruptcy code even has a section that says if a trust has proper spendthrift language in it, then the trust and its assets don’t even become a part of the bankruptcy estate.

However, you have to read the trust as a whole and unfortunately, a lot of spendthrift trusts have language inside of them that contradicts the spendthrift protection and or nullifies it.

Case in point, a month ago a bankruptcy attorney asked me to review a client’s trust agreement to see if the trust could be taken away during bankruptcy. The trust agreement did have the spendthrift language, but the trust also required that all income earned by the trust each year had to be distributed. Oops. There goes the trust protection. As soon as the assets are distributed out of the trust they are no longer protected and some bankruptcy trustee is going to be very happy.

Same thing with the trust I’m looking to purchase from the bankruptcy trustee. While the trust had spendthrift language, the trust document required the assets to be fully distributed. Why in the world would someone set up a trust so that the assets the trusts hold are protected, and then required that those assets be distributed to the cruel, mean world outside of the trust?

That little mistake is probably going to cost the beneficiary of the trust a couple hundred thousand dollars.

If you make a trust for your kids, or if your parents make a trust for you, make sure there is no language in the trust requiring assets to be distributed. Instead of forcing the distributions upon the kids at a certain age, make the kids the trustees of the trust as well as the beneficiaries. There have been a large number of bankruptcy decisions that have agreed there is asset protection even when a beneficiary is also acting as a trustee.

Don’t get me wrong; there will be a higher level of scrutiny if a beneficiary is also a trustee, but so long as you do things right it isn’t an insurmountable hurdle.

How do you do things right? Work with someone who has experience in both the trust and bankruptcy world. Don’t work with someone who is settling a personal injury case at 10, a real estate closing at 11, and drafting a trust to protect all your worldly assets at 12. …

Tim Berry, JD

When advisors plan for their clientele’s asset protection the question always arises over the issue of who will be the Trustee. At first blush, this question seems little more than a formality. At second blush this is no longer a question but a true concern for anyone or entity taking on the role of Trustee.

This “second blush” usually only arises once the advisor has been involved with some part or all of past legal litigation. Generally, advocates for clientele embracing a domestic asset protection trust have, fortunately, not acted as the Trustee in which litigation arose. Many times the newly appointed Trustee will not even have a provision for compensation or indemnification should litigation arise. In this article, I am only focusing on domestic asset protection trusts and the consequences to the acting Trustee. As the news media of several states have informed the public on the benefits of a domestic asset protection trust and the trusted advisors promote such trusts, little discussion is brought into the advisor/client discussions except to hear the rhetoric that domestic asset protection trusts, DAPT, are safe and your assets never leave the shores of the United States or even your state of residency.

In the operation of a trust that has as one of its purposes the protection of client assets, the risk is ever present in the Trustee being sued. Generally, when a creditor is seeking to determine whom to sue over assets within a trust, the Trustee becomes the main target with the best potential for creditors to obtain some financial relief. Some advisors suggest that trusts are not held to any legal status and therefore can not be sued. With this argument, the creditors will then seek the next easiest potential defendant, the Trustee. The creditors will entertain the claim that the Trustee be sued in the Trustee’s personal capacity. If this happens, the Trustee may seek indemnification from the Trust assets, but the trust deed may prohibit this indemnification, and/or the laws of the state will deny relief under indemnification. These trusts act to not only protect the individual who established the trust from creditors but also the Trustee as a potential creditor.

Trusts were a creation of common law as it came down from the courts of equity in Great Britain about 500 years ago when people who created their trusts were able to bifurcate benefits of ownership from ownership obligations. Over these 500 years, trusts never reached the level of law that would allow trusts, themselves, to be sued. The trusts were never actually recognized to be named in a legal lawsuit as opposed to a court of equity.

Currently, in the United States, lawsuits are compelled to go against the defendant Trustee in their/its personal capacity and then force the Trustee to attempt reimbursement of their financial loss from the trust’s assets. Now 48 of the 50 states have sought to bring some equitable relief to the Trustee by adopting and subsequently modifying the Uniform Trust Code or the Uniform Probate Code. This modification acts to bifurcate the entity of the trust from the Trustee which then allows a severing of liability to the Trust as to the Trustee and permits a lawsuit claim to stand for liability of the Trustee not in their/its personal capacity but rather in their/its representative capacity. Note, that the two states that have not adopted this modifying code are Mississippi and West Virginia.

Even in these 48 states, the Trustee is not home-free by any stretch. The Trustee may still be charged as liable in an action in contract law or tort law if the Trustee is held personally culpable or the Trustee did not adequately disclose their/its overt actions in their/its capacity of representation under contract law. In addition, even with this adoption of the Codes, the Trustee is still not out of the legally expensive woods of litigation because the modified Codes merely authorize the litigation claim in a Trustee’s representative capacity and the litigant is not barred from proceeding against the Trustee in their/its personal capacity. Recently, there is a marked judicial trend to allow the trust to actually be sued as a legally recognized party. However, even with this recent trend appearing in our courtrooms, plaintiffs will be filing suit against whomever they believe is solvent as an act to bring about a settlement with damages for the plaintiff.

At this point, I also acknowledge that the United States Government, specifically the U.S. Treasury, holds trusts as taxpayers with tax forms to file and tax identification numbers assigned to them and bank accounts allowed at financial institutions. However, in federal civil procedure, when a lawsuit is to be heard by the federal courts, as is what generally happens when there the plaintiff and the defendant are from different states, the federal courts will then determine diversity and resort to state law, not federal law. Remember, no state has stretched the long-arm statutes to bring the trusts under the definition of an entity for being a party to a lawsuit.

Knowing of these inherent risks, there are now four states that help the Trustee avoid lawsuits in a personal capacity. Alaska, Delaware, South Dakota, and Utah statutorily protect the trustee by prohibiting lawsuits alleging claims against the Trustee under the issue of personal capacity. Caveat, these four states statutorily limit Trustee liability in acts of tort or contract but still can be sued and held liable for acting or forbearance to act in some personal culpability.

A Trustee is still not free from risk. As a potential co-trustee or a successor trustee, you may not be responsible for the tort or contract of the other co-trustee or a predecessor. However, the plaintiff will seek recovery from all parties it includes in its Claim, and upon discovery and finding you are a co-trustee or successor trustee your name will be added to the long list of “John Does 1-100” and it will subsequently be your burden to seek recovery from the culpable co-trustee, predecessor trustee, successor trustee, or from trust assets that a court determines is warranted and permitted. Knowing that your recovery is not allowed against the trust assets, then your effort will be to find a solvent and culpable trustee and, if you are lucky, malpractice insurance policies that cover this type of reimbursement.

Conclusion

Although these domestic asset protection trusts are heavily promoted by states and advisors, there are serious consequences. Even if there is a lawsuit and you are later found to be not liable or able to seek adequate reimbursement, the nightmare of a lawsuit that takes on its own life of claims, counter-claims, new parties joined, summons, discovery, depositions, interrogatories, and endless court appearances over a period of years can ruin your personal and professional life.

If you have any questions, give us a call or email us so we can discuss your particular situation.

Michael B. Nelson, Esq.

I chose to include both cases to drive home my point that the courts are beginning to view a single-member LLC as a disregarded entity under multiple scenarios. Albright was a federal bankruptcy case where the entity was disregarded and Littriello was an employment tax liability case where the entity was again disregarded and the owner, Littriello, was found liable for the entity’s taxes.

From that newsletter, we received tremendous responses. So I wanted to take a moment and share with you some things that could have been done to improve the structures discussed in these cases that may have changed the outcome.

In Littriello, the taxpayer was found liable for the entity’s liabilities and was treated as a sole proprietor. What the taxpayer wanted to do was avoid the double taxation of a C-Corporation while trying to maintain the asset protection features that come along with owning a business as an LLC.

Had he worked with a CAPP advisor, for example, he would have been counseled on the “correct” way to set up his entity. He would have learned that a single-member LLC without the proper election to an S-Corporation results in the entity defaulting to the status of being a sole proprietorship. As a sole proprietor, the owner of the LLC has personal liability for all of the entity’s liabilities. In other words, had he or his CPA or attorney filled out form 2553 (“check the box”) to have the LLC treated like an S-corp., he could have avoided personal liability for the entity’s liabilities and some amount of employment taxes for any “distributions” he takes from the entity each year.

At the APS we believe, and the recent court cases seem to be of the same opinion that single-member ownership of an LLC offers little to no asset protection. We always suggest that if you are going to use an LLC for asset protection purposes then you must have an LLC that is set up in the correct jurisdiction (a state that has good charging order language in the statute) and it must be multi-member.

One more thing, many people replied to our recent newsletter wondering if a husband and wife would be considered multi-member. My response to them is that the courts, so far, have not defined what multi-member means and that many planning structures involve the husband and wife as “individual” owners; look at family limited partnerships which are excellent estate and asset protection planning tools.

The IRS also recently released a bulletin concerning the election of a husband and wife’s unincorporated business. Here we are discussing LLCs but I thought this was worth noting.

The IRS stated: “An unincorporated business jointly owned by a married couple is generally classified as a partnership for federal tax purposes.” The IRS went on to state that the married couple may not elect to be treated as a partnership and it gives reasons for not electing for such treatment.

However, what I believe is important and why I included this short piece in this newsletter is that the IRS bulletin also stated that “a business owned and operated by the spouses through a limited liability company does not qualify for the election.” By “the election” they mean the election to be treated as a partnership.

My reading of this IRS bulletin leads me to the conclusion that a husband and wife who are the sole members of an LLC should have their entity respected as a multi-member entity by the courts and the IRS. If you would like to read that bulletin, please click here.

The purpose of this newsletter is to, again, convey the importance of proper structure, setup, and implementation of your asset protection plan.  And, for those advisors who may be counseling their clients on single-member LLC ownership, I wanted you to be aware of these two separate scenarios where the courts have attacked single-member LLCs and remind you to be careful when giving advice to your clients on entity selection