Physicians and other healthcare practitioners know all too well that they live in a highly litigious society. Practitioners don’t have to be in a high-risk specialty to appreciate the importance of protecting personal assets from the over-reach of large judgments from lawsuits.
The potential personal impact of judgments from malpractice claims is only part of a broad scenario of potential liability. Practitioners face potential general liability from lawsuits over faulty products provided by a third party, sexual harassment, employment discrimination, breach of contract, workplace accidents – slip-and-fall injuries – and the list goes on.
The time to make sure your assets are protected is now, not when there’s a claim. Typically, moves to shield assets after a claim is filed fail to pass muster with courts.
Some physicians make the mistake of assuming that by setting up a corporation, they are adequately shielding their personal assets from claims. Yet, as claims sometimes “pierce the corporate veil” to seize personal assets, as lawyers say, this tends to be fallacious logic.
There’s another side to asset protection that is sometimes underappreciated. By structuring your assets properly, you can not only shield them from claims, but also reduce your tax burden and accomplish estate planning.
Laws on asset protection vary by state, so it’s important to get local advice on what works best in your location. Structures for effective asset protection include three basic categories:
1. Retirement Accounts
This is the easiest and most tax-advantaged way to shield your assets from judgments and creditors. By directing as much of your income as possible into 401(k)s and IRAs, you’ll also benefit from tax-deferred asset growth. ERISA-qualified plans like 401(k)s have unlimited protection from claims, and IRAs are generally exempt up to a limit of about $1 million in assets, though this varies by state and the applicable limit may different for creditors/judgments than for bankruptcies. There are annual contribution limits to these plans, and you generally can’t withdraw the money before age 59.5 without a 10 percent penalty. SEP IRAs, which are used by many small business owners including physicians, may or may not be protected depending on state law. In addition, the rules on rollover IRAs and after-tax Roth IRAs can be complex in terms of asset protection, so it’s important to get advice based on statutes and case law in your state.
2. Domestic Asset-Protection Trusts
At least 16 states – including Alaska, Delaware, Rhode Island, Nevada, West Virginia and South Dakota – allow anyone to set up an asset-protection trust, even if they don’t reside there. This can be a complex area, but generally any type of asset including cash, securities, real estate or life insurance policies can be placed in the trust. Withdrawals can be made, but only at an independent trustee's discretion. Some states won’t allow any claim to reach into these trusts unless fraud is proved. In other states, it’s easier for creditors to seize these assets. For years, off-shore asset protection trusts were popular but recent efforts of the IRS to curtail this tax-avoidance strategy have discouraged their use.
3. Annuities and Life Insurance
These vehicles allow you to shield assets from creditors, with the limit dependent on the rules of the state involved. Texas and Florida have strong statutes protecting these accounts from claims. Florida also exempts primary residences from claims, so it’s not unusual to see people there paying off their mortgages and then pouring their non-qualified assets into annuities and life insurance. But even in these states, to get reliable protection, such structures must be set up long before there’s even a hint of a claim.
Annuities come in many varieties, including fixed and variable, and some have long-term care riders. These are basically contracts to provide a stream of income in exchange for a lump sum provided at the outset. The money can be invested at a fixed rate or a variable rate, often tied to stock market returns. Some people buy so-called longevity annuities that start payments at a later age, say 80 or even 85. The thinking here is that if you do live to a ripe old age, you’ll have a new stream of cash to supplement your lifestyle or even pay for long-term care.
Keep in mind that annuities come with their own set of fees. And they tend to come with long lock-out provisions that make dissolving these contracts prohibitively expensive.
Annuity gains are subject to ordinary income tax so think twice before swapping income on which you paid low capital gains tax rates for the higher ordinary income tax rates on annuity gains. Again, as with most of these strategies, this is not do-it-yourself territory, so seek professional advice.
Trey Smith is a private financial advisor at SunTrust Investment Services, Inc., who services high-net-worth individuals. In addition to being a certified financial planner (CFP), Smith is a certified investment management analyst (CIMA), a chartered financial consultant (ChFC), a certified private wealth advisor (CPWA) and a chartered retirement plan counselor (CRPC).