Preparing for the Next Recession—Part II: Playing Defense
In the previous installment, I wrote about “playing offense,” which involves the money-making opportunities during the next recession, found here: https://www.linkedin.com/pulse/preparing-next-recessionpart-i-playing-offense-charles-castellon/. This article discusses legal concepts for protection during hard times. Start preparing for the next recession.
On the other side of opportunity lies danger and that’s what “playing defense” is about. You can call it “asset protection” or “wealth preservation.” But it comes down to smart strategic planning to shield what you have against bad things that may happen.
The One Thing You Can’t Do When Protecting Your Assets
There’s a legal reason why proactive defensive planning is important. In Florida, as in other states, there’s the legal concept of “fraudulent conveyance” (FC). Simply put, FC means that you can’t transfer assets for the purpose of avoiding or delaying creditors’ claims. I previously wrote about FC here: https://www.celebrationlaw.com/one-thing-cant-protecting-assets/
For example, a creditor may win a court judgment against you and then come around to collect. The judgment creditor has the legal right to see your books and make you answer questions under oath about your assets to help them collect. For example, you were to transfer title of a free/clear property to a family member for less than fair market value. This transaction would likely give rise to an FC claim to seek to unravel that deal and take the asset.
Legal Aspects of Fraudulent Conveyance (FC).
That’s the legal concept of FC in a nutshell, but it’s much more nuanced. The intent of the debtor is a key element a court considers in deciding an FC claim. Because “smoking gun” evidence of the debtor’s intent is rarely found, courts will examine the surrounding circumstances of the challenged transaction to determine if they did it for a proper or improper reason.
If the debtor were to put all their assets in sheltered places during a time when they have no outstanding debts, collection actions or judgments against them, it will be much harder to overturn those transactions after later troubles. If you transfer title to that property discussed above the day after you’re served a lawsuit, or right before a court judgment is entered, good luck with that.
Experience As a Business Owner
My personal experience as a business owner is proof of concept of the principles discussed here. After enjoying great initial success when I founded my former law firm in 2008, the business would suffer several years later. Overhead got out of control, I made mistakes. Unfortunately, it became a cash-eating monster. I put much of the money I had taken out of the firm back into it and struggled to repay a commercial line of credit with a personal guaranty.
Sound asset protection planning during the successful times gave me the leverage to negotiate a favorable resolution of the debt. Because I was effectively judgment-proof. This was the turning point on my way to economic recovery.
Where to Put Your Money for Protection—Exempt Assets
Because FC restricts your strategic planning choices, it’s crucial to shelter your assets while you don’t have a financial care in the world. The heart of any asset-protection plan is maximizing the benefits of exempt asset classes. Certain assets are exempt from creditor claims because of state and/or federal law. This is where we should strive to keep as much of our wealth as is practically possible. Like the 90’s one-hit-wonder, MC Hammer, you can tell anyone trying to take what you have, “you can’t touch this.”
Among the most common types of exempt assets are qualified plans. These are accounts including 401k, IRA, 529 college savings accounts and employment pension plans, both private and public. With very narrow exceptions, qualified plans are off-limits to creditors.
The insufficiency of retirement savings is a looming national economic crisis. Most of us would benefit by increasing contributions to these accounts for retirement planning purposes anyway. An additional, largely overlooked benefit is that these funds are exempt from creditors.
Limited Liability Companies
Business entities, such as limited liability companies and others, are used to separate an individual’s personal and business assets. For small business owners and investors, LLCs are the most popular entities for their ease of use in setting them up and maintaining them. LLCs also have powerful asset protection benefits.
There are “outside creditors” who may have claims against the individual member(s) of an LLC, but not the business itself. “Inside creditors” have claims against the company. But not its individual members. LLCs are set up to prevent outside creditors from raiding the assets of the business. Similarly, inside creditors are stopped from taking the individual members’ personal assets.
In Florida, a judgment creditor of an individual LLC member may get a lien against that member’s share of the company, known as a “charging order.” The LLC, however, is not required to distribute dividends to its members. So that creditor may be prevented from collecting. A cruel legal outcome is that the creditor may be taxed for a share of the company’s profits linked to that debtor LLC member. This is due to the charging order, while unable to touch the winnings of their lawsuit.
Florida Homestead Property
In Florida, your homestead property is exempt from creditors except for very limited circumstances including the mortgage lender for that property, the HOA or contractors with a lien for payment due from work done on the home. The homestead protection is so strong that you can invest money that would otherwise be fair game for creditors. Such as in your savings account, into your homestead without violating the FC law.
Yet Another Good Reason to be Married
Marital property, called “tenancy by the entireties” (T by E) is also exempt from creditors when only one spouse is the debtor. T by E protection extends to a wide array of asset classes. This is including real estate, cash, personal property, and many others.
The benefits of T by E don’t survive the death of a spouse or divorce. This protection is also lost when both spouses are equally liable for a debt. For example, if spouses are co-borrowers on a mortgage loan, a foreclosing lender could pursue marital property in the event the value of the foreclosed home doesn’t cover the debt owed. The public policy rationale of protecting an innocent spouse from the debts of the other doesn’t apply when they both default on the debt.
Get Your Swiss Army Knife
Another exempt asset is the cash value of a whole life insurance policy along with the principal and income streams from annuities. Talk with wealthy people and most will tell you they invest in permanent life insurance policies. Most of us need the death benefit to protect our families from the economic impact of one sure thing in life.
Whole life insurance is the Swiss Army Knife of financial products because of its versatility. The cash value accumulation, arbitrage opportunity (by investing money borrowed against the policy’s cash value), and tax-free inheritance legacy satisfy “playing offense” considerations. There are other benefits and permanent insurance policies can be designed to meet the unique needs of each family.
The Key is Quadrant 2
Asset protection isn’t sexy. Also, it doesn’t have the “sizzle” to sell seminars like the get-rich programs. It’s important, though not urgent, and people tend to buy what they want, rather than what they need. As the fraudulent conveyance discussion above shows, by the time the situation is urgent, it’s too late to play good defense.
Stephen Covey’s famous book, The 7 Habits of Highly Effective People describes my favorite universal success principle. Covey talks about the four quadrants of how we spend our time, on a grid with important/not-important and urgent/not-urgent categories. A big key to life and business is taking care of Quadrant 2—the important/not-urgent. That’s where legal planning, including asset protection and estate planning squarely falls. It’s always important, but never urgent, until it is.
At Widerman Malek, we help investors, business owners and families play strong defense to defend what they’ve worked so hard to build through strategic planning services. Contact me to get started while you still can. Start preparing for the next recession today.