A California Living Trust Attorney Discusses Asset Protection Strategies & Trusts
by Jeffrey Rosen, Attorney at Law
Here’s a disaster I see all too often in my practice, and it breaks my heart: An inheritance which required a lifetime to accumulate is taken in an instant by a predator, creditor, or divorce after it transfers to a loved one.
Lawsuits are at an all-time high. Divorce hits at least half of marriages. And here in 2020, as I write these words, bankruptcies have become quite literally pandemic.
You worked hard to save your money. You denied yourself extravagances. You invested your funds wisely. These habits enabled you to accumulate wealth—a true life accomplishment. You’re rightly proud that when you are gone, you will continue to provide for the wellbeing and support of your loved ones, possibly with a significant inheritance.
But any inheritance, especially a significant inheritance, can become a target. Unless you take important legal steps to protect your legacy before you pass away, it may well be lost, and lost quickly.
These asset protection strategies go well beyond creating a Living Trust or designating beneficiaries on a bank form. They add only a little extra work to the estate planning process, but they can prove highly effective. In California, asset protection strategies may be vital.
Imagine the following tragic scenarios:
Just 1% at Fault, but Taking 100% of the Hit
Upon your death you leave your house ($650,000), a bank account ($25,000), and your remaining IRA funds ($325,000) to your daughter Eileen. Indeed, all these wonderful assets transfer directly into Eileen’s name.
Eileen is smart and diligent, and by the time of your death she’s attained a high level of financial responsibility. A few months after your death, she’s driving in Los Angeles, California when a teenage drunk-driver runs into her car, causing her car to hit a pedestrian. Eileen is ok, but the pedestrian is badly injured and brings a lawsuit against both the drunk driver and Eileen. The Judge affirms the pedestrian’s damages are $1 million, and a jury determines that the drunk driver is 99% at fault and Eileen is just 1% at fault for the accident.
So far this sounds like justice. But what happens if that drunk driver cannot pay his 99% of the damages? In California, this scenario sticks Eileen with 100% liability for the $1 million damages, because she can pay; even though it was determined she was just 1% at fault. No kidding.
And now, guess what? The pedestrian gains access to the house you left behind, along with the bank account and IRA you lovingly left Eileen –because she is now the legal owner of those assets. Disaster has struck.
Bankruptcy Trustee Goes After the Goods
You die with a $1 million estate which you successfully leave to your responsible son, Trevor. Trevor is a respected local business owner with a popular restaurant held in his name. He was never able to keep much in the bank—and if his business were to fail, he could have effectively walked away.
Suddenly, after years of success, a viral pandemic sweeps through the country, prohibiting townsfolk from socializing publicly, and decimating the dining industry.
Trevor’s restaurant survives for a bit, but after months of lost income he is forced to file for bankruptcy. Only now you’ve provided him with money in the bank. A Bankruptcy Trustee is appointed and requires Trevor to use your $1 million legacy to satisfy the restaurant’s creditors.
Son-in-Law Cuts Out and Takes Half
Your daughter Tamma and her husband Mark are happily married and living in California when you pass away. Tamma inherits your estate, and she uses half of your generous inheritance to pay off the mortgage on the house she and Mark own together. The other half is transferred to their joint bank account. So far, so good.
Except that five months later, Mark is unfaithful, and the marriage falls apart. Indeed, it’s Mark who files for divorce—maybe because he sees that he can now cash in. When he files, he argues that as part of the Marital Settlement Agreement, he is now entitled to one-half of the assets acquired with Tamma’s inheritance because Tamma commingled her inherited assets with him over the last five months, and as a result, the assets became community property. Mark prevails in California Family Court and walks away with one-half of the inheritance you worked so hard to provide your daughter.
How to Protect Your Legacy from Predators
Each of the catastrophic scenarios above are based on true stories, and each is especially tragic because the children did not commit any wrongdoing. They didn’t even act irresponsibly. Rather, the threats were outside their control, and the laws in their state of California happened to work against their interests.
Just as tragically, in each case good planning by the parents could have prevented the loss.
How? It all lies in the definition of “ownership.”
The secret to effective asset protection lies in structuring an estate so that your heirs will get full control of your assets, but not actually own them. As John D. Rockefeller once advised, it’s best to “Own nothing, but control everything.” That’s because, by law, what you don’t own can’t be taken from you, even it if it is completely under your control.
Control without ownership can be created using an Inheritance Protection Trust, or for retirement assets, an IRA Legacy Trust. Both of these asset protection strategies can allow your loved ones to completely control, access, and manage their inheritances while simultaneously enjoying protection from potential creditors, bankruptcy, lawsuits, and divorce.
How to Control, But Not Own
A good estate attorney can structure an inheritance in a manner where instead of leaving wealth to your loved one directly in their name, the wealth is left in a trust that continues to exist after your death. You decide who may control the wealth within the trust (the Trustee) and who will benefit from that wealth (the Beneficiary.) Whether you appoint your loved one or an independent third party to control the assets within an Inheritance Protection Trust, if properly constructed, all the funds may benefit your loved ones while remaining safe from creditors, bankruptcy, lawsuits, and divorce.
One additional benefit of an Inheritance Protection Trust is that the language used to create it can be drafted right within your Revocable Living Trust. Most people, in particular Californians, already seek to establish a Revocable Living Trust to avoid probate, direct their assets to the proper beneficiaries, and plan for potential taxes upon death. They can add the feature of asset protection by including an Inheritance Protection Trust.
If you already have a trust and are considering an Inheritance Protection Trust, good news! Many of our clients with existing trusts don’t need to start from scratch. In many instances you may need only to formally update your existing trust by creating a Restatement. A Restatement has the added benefit of bringing all the language of the trust up-to-date—and typically legal fees are less than starting from scratch.
Retirement Accounts Require a Unique Plan
It has become common for a family’s most valuable asset to be a retirement account like an IRA, 401(k), 403(b) or tax-deferred annuity. It used to be that inherited retirement accounts offered some protection from predators. But in 2014, the United States Supreme Court unanimously ruled that inherited retirement accounts are no longer considered “retirement accounts” subject to protection from the creditors of a beneficiary. The case was called Clark v. Rameker, 573 U.S. 122 (2014), and it has had a devastating impact.
All in all, creating asset protection for retirement accounts has become more important than ever.
For reasons too lengthy to discuss here, an Inheritance Protection Trust is typically only appropriate for non-retirement assets such as a house, cash or stocks – not retirement accounts.
Here at CunninghamLegal we offer special expertise in creating a highly-specific kind of trust to deal with the complex laws around retirement accounts, called an IRA Legacy Trust. An IRA Legacy Trust uses several of the strategic concepts found within an Inheritance Protection Trust, but it’s equipped with a sophisticated tax plan to account for the income tax obligations that exist with most inherited retirement accounts. Importantly, it can also be sited in a state without state income taxes, even though your beneficiaries may reside in a high-tax state like California. Combined with the asset protections of “controlling, not owning,” such a trust can allow you to leave a powerful and safe legacy to your loved ones.
Protection Long After You Are Gone
If you are the kind of person who says, “What do I care? By the time any of this matters, I’ll be gone anyway,” these planning strategies may not be for you.
But if you are savvy like most of my clients, and you see the value of providing protection for your loved ones even after you are gone, I encourage you to schedule a consultation with a competent estate planning attorney. Together you can determine whether an Inheritance Protection Trust or IRA Legacy Trust may be appropriate for you and those you love.
About the Author
Jeffrey Rosen, attorney at law, received his Bachelor of Arts degree from UCLA and earned his Juris Doctor from Pepperdine University in Malibu, CA, where he was a member of the international legal honor society Phi Delta Phi. Jeff devotes his practice at CunninghamLegal to estate planning and trust administration and he is currently working towards becoming a Certified Specialist in Estate Planning, Trust, and Probate Law by the State Bar of California.
