Have you heard the story of the bag lady who was sued for $10 million? I didn’t think so. Lawsuits aren’t typically filed against poor people; they are filed against those who have or are perceived to have “deep pockets.” If you have substantial assets or are coming into a windfall from a sudden wealth event such as an inheritance, exercise of a large stock option, sale of a business or from any other source, there are several money moves you should consider to help protect your wealth against loss from judgments or lawsuits.
Unfortunately, we live in a very litigious society. These days, anyone who has the semblance of wealth is a potential target. What triggers a lawsuit can often be something beyond your control. It might stem from a car accident in which someone was injured. You may have not even been driving the vehicle or been inside the vehicle at the time of the accident. But it was your car. The lawsuit can follow a paper trail back to the owner of the car.
Another common trigger is boating accidents where someone else is using your boat or jet ski. Renters or visitors can sue if they are injured while on your property. It could be as random as a tree falling on your neighbor’s property or a failed business endeavor. Believe me, the stories I have heard would challenge the most creative minds!
So, what should you do? Here are a few steps you should consider taking. All or most of these steps need to be taken before an incident occurs. Once an incident occurs, it is very hard to go back and take steps to protect your wealth. There is a pesky concept called “fraudulent transfer” that precludes you from trying to close the barn door after the horse has gotten out.
Your first line of defense in litigation should be insurance. Make sure your personal umbrella liability coverage is for an amount at least equal to your net-worth. In addition, if you are about to receive an inheritance of $2 million, add that to your current net worth and get at least that total in coverage. The cost for this type of coverage is relatively inexpensive, especially given the potential benefit if you are ever sued.
Keep in mind that it is important to clearly understand the policy. You need to know what it covers and what it does not cover. For instance, most policies will not cover “illegal acts.” While many people ignore this clause, (thinking they would never do anything illegal,) this might include someone driving your boat while under the influence of alcohol or a minor drinking and driving.
Since umbrella liability insurance is SO inexpensive relative to the benefit, I always advise getting the most you can possibly get. Why? Let’s say you are being sued for $30 million for the death of a plastic surgeon who died as a result of an accident in which you were driving. You want the insurance company ‘on the hook’ for the highest amount possible. I have noticed if the insurance company is potentially on the hook for $10 million, you will get the “A” defense team. If they are ‘on the hook’ for $5 million, you’ll get the “B” team, etc. I see so many people who have a large net worth but only $1 million in liability coverage. You need to realize if you lose that suit, you could potentially be responsible for paying the difference.
As a rule of thumb, with the exception of your personal residence, you should consider having your assets titled in the name of an entity that offers asset protection in the state in which you reside. If you have assets titled in your individual name or in joint name with your spouse or partner, there is virtually NO asset protection (with the exception of Joint Tenants by the Entirety in Florida). Depending upon the state in which you live, there are legal structures that can be the legal holder of your assets so you are not completely “naked” when it comes to asset protection. The nuances of each are too much to go into in this article but a few of the legal structures we often use are:
People who are serious about asset protection should certainly consider discussing one or more of the above. Keep in mind, in many states, assets held in 401(k)s, IRAs and other pension-type accounts are considered protected. However the rules on those types of assets can vary from state to state.
If you have rental property or expect to invest in income producing real estate, you should consider creating a business entity such as an LLC or corporation to shield your other assets from a disgruntled tenant. By doing this, if your renter sues you for $5 million, they can attack the assets in the entity that holds the real estate but the rest of your personal assets are protected. If you have more than one rental property, it is prudent to create a separate business entity for each rental property or consider a Nevada or Delaware Series LLC, which is designed to protect each property within a single LLC.
Any money you deposit into a joint account with your children, elderly parents, roommate or business partner could be at risk. If the joint owner files for divorce, incurs a tax lien, or lawsuit judgment, the entire account could be wiped out. If you have a need for a joint account, you might want to keep the account balance as low as possible.
Informal business partnerships are ticking time bombs. Why? Just like joint accounts, you could be responsible for the actions of your partner. But unlike a joint account, a lawsuit against your partner could put all of your assets at risk. For example, suppose you and a friend have an informal agreement to partner and provide consulting services. If your partner is involved in an accident on the way to consult with a client, your personal assets could be in jeopardy. To protect your wealth, you should formalize your business relationship by forming an entity to provide you with legal protection.
If you have a small business or do part-time work on the side without having a formal business structure such as an LLC or a corporation, you are operating as a sole proprietorship. The “sole” means it’s just you, so unlike a partnership, you don’t have to worry about a partner’s actions, but all of your personal assets could be at risk if you are sued.
It is often what we don’t know that can hurt us. For those of you who have created financial independence, you need to take steps to protect your wealth. Accidents happen; lawsuits result. The question is: how much of your wealth will be available to satisfy a judgment? If you do nothing, the answer could be 100%. I encourage you – no, I implore you to see wise counsel and protect your wealth. As I said earlier, once an incident occurs, there’s virtually no way to go back and close the barn door; the time to close that door is now, before anything happens that could threaten your financial security.