While many Self-Directed IRA Owners aren’t exactly the Rockefellers, most people who choose to self-direct their IRA investments and use self-direction in other retirement accounts have, on the whole, been at least moderately financially successful – and they have accumulated some assets both within and outside of their retirement accounts that are worth protecting.
Unless you are careful, though, others take notice – and you may become the target of a lawsuit by some party pursuing a grievance real or imagined. If it’s obvious you have some collectible assets to protect, or if a search for assets held in your name turns up a lot of net worth that would be collectable, a potential plaintiff won’t have trouble finding an attorney to take the case on contingency.
That’s why Self-Directed IRA Owners understand it’s important to know how to protect yourself against the threat of lawsuits, judgments and bankruptcy.
Now, that’s a big subject – and entire volumes have been written on it. But there are a few principles you can keep in mind to protect yourself and all you’ve accumulated against those who would try to take it away.
- Don’t wait. You must take action to position assets before you smell a lawsuit. If you wait until after your tenant slips and falls, or after you cause that wreck or your teenager runs over that pedestrian, courts may disallow any transactions you make in the effort to shield assets from creditors.
- Make full use of your IRA, including your self-directed IRA and/or real estate IRA, and other retirement accounts to shelter assets from lawsuits. Federal law protects IRA assets up to just over $1 million. Assets in 401(k)s, including self-directed solo 401(k) plans, are generally held in trust for the plan participant. These assets get treated as pensions, rather than IRAs, and protection is even greater. Even the IRS has trouble cracking open a properly-designed 401(k) plan.
- Don’t be a conspicuous consumer. People who live ostentatiously attract attention – and lawsuits. Invest wealth – don’t flaunt it.
- Understand homestead exemptions in your state. States generally give varying levels of protection to equity in your primary residence. In Texas and Florida, home equity protection is unlimited – provided you’ve lived in the home long enough.
- Consider offshore planning. Even if you have a judgment against you, U.S. courts have no jurisdiction over assets held outside of the country. U.S. law allows you to hold overseas real estate within an IRA (though local laws may vary about how you may title ownership).
- Hold assets that you can’t hold in IRAs and other retirement accounts – self-directed and otherwise, in trusts – particularly an irrevocable trust. If you hold assets in a revocable trust, there is still the danger that a judge will order you to revoke the trust or pull assets out of it. If you refuse, you could be held for contempt of court. Use of an irrevocable trust short-circuits this possibility. The downside is you lose much of your control over the asset.
- Avoid general partnerships of any kind. General partnerships put everything you own on the chopping block due to mistakes your partners make or torts your partners Avoid sole proprietorships, for that matter. Separate your business interests from personal assets – or a business claim could wipe you out, personally.
- Consider the use of LLCs, including Family Limited Liability Companies (FLLCs) and Family Limited Partnerships (FLPs) in addition to corporations. LLCs and their derivatives make it more difficult for creditors to collect dividend distributions compared to corporations. A court can compel the sale of a fractional interest in a corporation. It can’t compel the sale of a fractional interest in an LLC. The most the creditor can get against your will is a charging order directing you to share proceeds of any distributions or dividends with the creditor. But you may never take any money out of the LLC. Meanwhile, your creditor may get tagged with tax on imputed income – that is, money that accumulates within the LLC but that you never distribute – a state of affairs that may force him or her to settle on favorable terms. Note: Some states may not recognize LLCs with only a single member. Check with an attorney licensed in your state for details.
- Be wary of asset protection scams. For example, Nevada corporations, bearer bonds, unusual but patriotic-sounding trust names (Constitutional Trusts, Patriot Trusts, Common Law Trusts, etc.) and Pure Trusts have all been torn apart by creditors’ lawyers.
- Life insurance and annuities. State law varies widely on the asset protection benefits granted to these assets. Some states, like Florida, provide unlimited protection for cash value in life insurance and for annuity contracts. Check with an attorney licensed in your state.
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