There are steps that dentists can take to protect their wealth. It pays for them to bring on a professional who knows his or her way around the different options of wealth management.
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This article originally appeared in the Principles of Practice Management e-newsletter. Subscribe to this informative twice monthly practice management ENL here.
We live in a very litigious society. You’ve probably had friends, business associates, or family members experience the ordeal of a lawsuit. Chances are you may have been targeted yourself. Or perhaps you’ve seen how a falling out between business associates or actions of a wayward accountant can upset the best laid plans of even the most successful people.
You’re not alone with your concerns. Research shows that roughly 86% of successful business owners worry about unexpected lawsuits or losing assets through divorce. Despite this troubling statistic, other studies found that just over a quarter (27.5%) of business owners have put asset protection strategies into action.
Legal actions are just one of many events that can blindside someone and drain you of time, energy, and financial resources. The reality is that your success and stature as the owner of a prosperous dental practice make you a target for a wide spectrum of potential misfortune. From creditors, judgments, divorce, tax audits, partnerships gone wrong—there are many forces that can quickly erode or drastically reduce your business and personal assets.
But before you assume there’s little you can do should such a misfortune befall you and your practice, here are some proven steps you can take to protect the assets you’ve worked so hard to build, before calamity strikes. Making provisions now will save you incalculable costs and potential losses. Not doing so may endanger nothing less than the financial security of you and your family.
Asset protection as a defensive strategy: plan now, benefit when it counts
Most people with a significant personal net worth know instinctively that even though modern society operates on the rule of law, the law of the jungle still lurks in the hearts of those who would do us harm. Just as our ancestors chose shelters capable of being defended and armed themselves in anticipation of attacks, you must build an asset defense strategy now rather than when the necessity becomes painfully obvious.
The objective of asset protection is quite simple—to make it as difficult as legally possible for litigators, creditors, and others to win a judgement. Creating an impenetrable fortress of protection around your assets puts potential litigants on notice that going to court will require an expensive lawsuit that could stretch on for months or years. But now is the time to act if you want to avoid the risks associated with “after the fact” maneuvering. Fortunately, there are a variety of strategies available that effectively provide asset protection before a claim or liability arises. If any of these are missing from your life, I urge you to make it a top priority to remedy the situation.
Prepare in advance: later is too late
The time to ensure proper asset protection is in place is before a claim is filed against you. Having adequate insurance, placing some of your assets in another person’s name, or setting up a trust such as an irrevocable trust for the benefit of your children are all legal tactics to shield yourself from costly lawsuits and potential loss through a judgement. However, putting these mechanisms and others into play after a claim is filed will likely expose you to legal jeopardy under “fraudulent conveyance” or “fraudulent transfer” laws. The court system frowns upon hiding or protecting assets as a defense measure, which can have serious consequences beyond the original suit.
Keep it simple and sensible
As the spectrum of asset protection schemes has grown over the years, so has the nature of strategies to legitimately benefit from onshore and offshore trusts and retirement plans. Legislation such as US federal bankruptcy laws and the Employee Retirement Income Security Act of 1974 (ERISA) are also in place to exempt certain assets from creditors.
Inventiveness, however, does not automatically equate to the optimal approach. When the structure of asset protection plans is complicated and the transfer of assets is convoluted or suspect, they can collapse like a house of cards under the scrutiny of a judge. During a debtor’s examination, the client will be expected to describe specifics about how assets were transferred and where they are held, and the explanation must be logical and convincing. If the court is not satisfied, a ruling of fraudulent conveyance against creditors could occur, with disastrous consequences.
Conduct an asset protection check-up
Sit down with your wealth management professional or financial advisor to evaluate your liabilities and insurance policies. What assets might you have overlooked, or might have grown in attractiveness to potential litigants? The quickest and most cost-effective approach to gaining blanket coverage is to take out a large umbrella policy to safeguard assets. Placing your assets in someone else’s name, such as your spouse or adult child, usually places them beyond the reach of any legal action directed at you or your business.
Eliminate bankruptcy as a potential worst-case scenario
The effectiveness of filing for bankruptcy to “wipe the slate clean” changed with the passing of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Largely championed by credit card issuers, the law restricts consumers’ access to Chapter 7 bankruptcies that provide for the discharge of debt following liquidation of assets. The net result is that other forms of bankruptcy must be considered, including Chapters 11 and 13, neither of which are as forgiving as what could be accomplished prior to 2005. Bottom line—don’t make bankruptcy part of your vocabulary when considering asset protection under even the most trying conditions.
Learn from the playbook of the super-rich
High net worth individuals and large corporations have teams of attorneys and accountants to devise water-tight strategies to minimize liabilities of every kind. Here are some well-proven and yet often overlooked steps that you should expect an experienced and knowledgeable wealth manager to understand and recommend. These include:
• Equity stripping
Although the idea of borrowing money from a bank when you don’t need it may seem counterproductive, when used for the purposes of “equity stripping” it not only makes sense but could be the wisest financial move you’ll ever make. It works like this: You take out a bank loan and secure it with property of your business that is shown on the balance sheet (such as equipment, real estate, a vehicle, or even receivables and inventory). Should creditors or a litigant attempt to seize the encumbered assets, they would first have to pay off the bank loan, likely rendering the entire exercise without financial gain. Despite the simplicity and rock-solid effectiveness of this strategy, our research has shown that fewer that 10% of financial advisors are familiar with this strategy and less than 1% have ever used it with a client.
• Captive insurance companies
When it comes to accomplishing both legal tax reduction and asset protection, the use of the captive insurance company mechanism is one of the best. Put simply, these goals are achieved by setting up or leveraging an existing closely-held insurance company to insure the risks of your business as the “owner” of the insurance entity. Because in the eyes of the law and the IRS, the business owner controls the operations of the captive insurance company, including underwriting, claims decisions, and the investment policy, you can protect your business and personal assets from risk while shielding any underwriting profits incurred.
To qualify as insurance for federal tax purposes, the captive must truly be providing insurance from a legal standpoint, there must be provable insurance risk in play, and there must be a demonstrable shifting of risk and distribution of risk. Without all of these elements, all of the advantages are at risk of being disallowed.
For most small businesses, the 831(b) Captive, established with the Tax Reform Act of 1986, is the most practical. When instituted, the IRS allows 831(b) small captives with gross premium income under $2.2 million annually to pay taxes just on investment income, avoiding taxation on underwriting profit. Other forms of the captive insurance company that may be practical for you are the “rent-a-captive,” usually established by an insurance broker or captive management company, and the “protected or segregated cell captive,” a captive set up as a separate account for each insured entity. Both approaches avoid most of the cost and administrative overhead associated with having your own such entity. To determine if a captive insurance company will provide sufficient advantages, a detailed review of your current insurance is necessary. I have performed many such reviews for clients as a first step and do so on a complimentary basis.
• Onshore and offshore trusts
Trusts are widely used by the wealthy to transfer or “settle” assets with trustees who manage the trust property for their benefit. Assets placed in trusts are generally out of reach of creditors being they legally are no longer yours. Trusts also remove the obligation of paying income tax on gains made from the assets, and they often avoid estate and gift taxes. Properly used, trusts are a viable option for just about anyone if costs and fees are kept to a reasonable minimum, which is possible if a financial planner is used instead of a trust attorney.
The primary intent of either an onshore or offshore trust is to protect your cash, stock, real estate, and other assets and ensure your goals for the use of the wealth are followed now and after you die. In the US, many states allow for domestic asset protection trusts, while countries such as the Bahamas, Belize, the Cook Islands, and Nevis (among others) are good locations for offshore trusts. Rules governing these trusts vary greatly depending on the jurisdiction, so having a thorough familiarity of the laws of the domicile of the trust is critical. As with all asset protection strategies, rely on your financial brain trust before proceeding.
Get an expert on your side
Don’t assume most financial professionals are qualified to suggest and implement the most appropriate asset protection solutions for your situation. Many of the advanced asset protection strategies covered here are complex and therefore require a familiarity with and understanding of how they work to set up and execute them effectively. If poorly structured asset protection strategies have no “teeth” when they’re needed most, your assets many not be nearly as safe as you believe.
As one of the most important life decisions you’ll ever make, approach the development of your asset protection plan with the seriousness it deserves. Talk to colleagues and business associates for referrals to wealth management professionals whom they respect and who have a documented track record in this area. Regardless of your current satisfaction with your financial advisor, take the time to get a second opinion and compare notes. My hope is that you will print this article and bring up these topics with a wealth manager. If you have questions about any of these strategies, feel free to connect with me via email or phone and I’ll be happy to clarify.
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Tim McNeely is CEO of The LifeStone Companies and works with a limited number of entrepreneurial dentists for whom he can have a major impact. Using a consultative approach, he helps successful practice owners make smart decisions about their money by addressing their five biggest concerns—preserving their wealth, tax mitigation, taking care of their heirs, ensuring their assets are not unjustly taken, and charitable gifting.
