How to Protect What You Own From a Lawsuit
Lawsuits happen everyday, and sometimes good people are faced with the dilemma of wondering what can be taken from them and how they can protect themselves in the future from being over exposed to risk. Now I am not an attorney nor do I play one on TV, so you should definitely consult an attorney who specializes in bankruptcy for personalized and vetted information. Based on the research and courses I have done, here are some generalized principles to consider.
First and foremost, we live in a country with multiple states, and each state has their own laws regarding property. What I’ll mention here is predominately Texas based research, but if you travel and go to other states, you may be subject to their property laws, so use discretion and arm yourself with knowledge.
Chapters 41 and 42 are the specific sections of the Property Code that address credits claims, and boy is it interesting. For starters, did you know that your cemetery plot is exempt from creditors? That and your homestead are both exempt. Your homestead can have some limitations, not based on the price, but on the amount of land (10 to 200 acres depending on classifications). In addition to this, some of your personal property can also be exempt from creditors up to $100,000 for a family. There’s a pretty long list, but again an interesting tidbit is that only 2 firearms can be included in that exemption.
So basically, we can consider that your home is creditor protected and some of your belongings up to $100,000 in value. This is one of the many reasons that I am a big advocate of having a paid off house when you enter retirement.
The next major category that we will examine are retirement accounts, and to start with we will begin with employer sponsored retirement plans. These are plans under the Employee Retirement Income Security Act (ERISA). ERISA covered plans are exempt from creditors to the full amount of the account balance. These accounts fall under two categories: 1) Defined Benefit Plans and 2) Defined Contribution Plans. Defined benefit plans are plans that are designed to replace a percentage of your salary in the future – most commonly pensions. These would be TRS, FERS, TCDRS, TMRS, and others, as well as private pensions offered through companies. Defined contribution plans include any plan that you do not get a guaranteed payout, but instead you have a greater say in the investments or participation. These types of plans would include 401(k) plans, 403(b) plans, 401(a) plans, employee stock ownership plans, profit-sharing plans, SEP IRAs, and SIMPLE IRAs.
On top of our house, we can also add our employer retirement plan to the list of “safe” from creditors assets. But what about employer retirement plans that are rolled into an individual retirement account (IRA) or a Roth IRA?
Prior to 2005, there may have been a concern in moving money out of a 401k and into an IRA because you could be losing some shelters that are in the 401k. That year, however, The Bankruptcy Abuse Prevention and Consumer Protection Act (CAPCPA) of 2005 changed things and helped offer protection for contributions to and earnings in IRAs as well as Roth IRAs. The amount of protection started at $1,000,000, but is adjusted every three years with inflation and now is closer to $1,362,000. Not to worry if your IRAs are over that limit, that applies to your contributions and earnings, but if you rolled your 401(k) into it that amount is fully protected due to the fact that you contributed within a registered ERISA account.
Now that we have determined that your home, employer retirement account, and IRAs are all protected from creditors and lawsuits, what accounts might we have to look out for?
In Texas these are protected, but for many states it is not the case for inherited IRA accounts. Many states view these accounts as no longer retirement if you cannot contribute to them and are having to deplete them, so understand that varies greatly state by states. One thing to discuss with your estate planning attorney is setting up a trust for your IRA accounts so that when you pass away, your children, who may live in multiple states, will not have that exposure in owning unprotected accounts while they are taking the money out over 10 years.
Another kind of account to examine are your taxable accounts, and this includes your taxable brokerage investment accounts as well as your regular checking and savings accounts. These accounts do not have any creditor protection overall, but I did read that a handful of states like New Hampshire make $8,000 creditor protected in their checking accounts. What options do you have to help protect these accounts?
1) Utilize insurance products. By putting those investments into an annuity or insurance product, you gain creditor protection.
2) Invest in a 529 college savings plan. Yes, that is a little out of the box; however, many 529 plans are creditor protected and you can get your investment out tax and penalty free, however, any growth that you have and withdraw not used for education is taxed with a 10% penalty also.*
3) Create a trust. Many people use living trusts or revocable trusts as a way to keep accounts from going to probate, but those trusts do not offer creditor protection if they can be found. You could consider a type of irrevocable trust as a way to get money out of your control, but those types of trusts come with many rules and restrictions, so you’ll want to get a legal opinion or two to determine if that’s the best option for you.
4) Buy a safe or safety deposit box. This will not help an investment account, but for your savings it could be a way to have cash on hand protected and out of the reach of all but thieves.
5) Consider property and casualty insurance. There are policies designed to help you have coverage in the event of a lawsuit. Auto insurance, homeowners insurance, and umbrella coverage are all great options for paying an entity to bear the risk of pending lawsuits.
At the end of the day, many of us are probably fairly well protected from legal recourse against us personally. If you do have an exposed area that you wish to address, please reach out and we will be sure to help or point you in the right direction of a licensed professional who can.
Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional. *Rules and laws governing 529 plans are varied and subject to change. As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. Investors should consider, before investing, whether the investor’s or the designated beneficiary’s home state offers any tax or other benefits that are only available for investment in such state’s 529 college savings plan. Such benefits include financial aid, scholarship funds, and protection from creditors. The tax implications can vary significantly from state to state.
Investors should carefully consider the investment objectives, risks, charges and expenses associated with 529 college savings plans before investing. More information about 529 college savings plans is available in the issuer’s official statement, and should be read carefully before investing.