Don't panic! The real story on asset protection

Introduction

Asset protection specialists are not so special

Asset protection seems to be a hot topic for discussion amongst investors at the moment. As a result of the recent asset boom most investors find themselves considerably richer than they used to be. Perhaps it is human nature that only when we finally have some wealth does our focus shifts from how to make money to how to keep it. However, for some investors their increased wealth also brings with it an increased fear of “losing it all”. Unfortunately a new mini-industry of so-called Asset Protection “Consultants” or “Specialists” has sprung up to feed upon that fear. These Asset Protection Consultants seem, almost uniformly, to use tabloid-style emails and marketing letters with lots of phrases like: “stop scumbags legally stealing your assets”, “right now some gold-digging litigant could be planning to take you to the cleaners”, “how would it affect your future, your children’s future and your marriage” and other alarmist phrases, with numerous exclamation marks, highlighting and italics, to create a sense of urgency.

Don’t get me wrong, asset protection is an important issue for investors. However, the approach adopted by these asset protection consultants troubles me. Getting your asset protection right, requires a calm, informed and structured analysis of your risks and the available protective steps you can take. Instead, the asset protection consultant’s marketing campaigns unfairly use emotive language to prey on people’s fear of not being able to provide for their families after losing their assets. Certainly views about marketing methods can legitimately differ. No doubt these consultants are using the “hard sell” strategy because it works for them. If that was my only criticism of this “industry” then it would simply be no worse than many other advertising campaigns. But I have more fundamental concerns about these asset protection consultants. My questions are:

• First, what professional training, qualifications and experience do they have, to be able to give advice about asset protection?
• Second, what value do asset protection consultants add, for their fee or commission?

Now I’m not being precious or elitist here. There are many investors who have a very good understanding of how trusts and other asset protection methods operate compared with the average accountant or lawyer. However, there are three key differences between seeking advice about asset protection from your accountant or lawyer compared with one of these consultants.

• Firstly, there are minimum academic qualifications and ongoing learning requirements imposed on those professions – so your lawyer or accountant should know what they’re doing, particularly if they profess expertise in the area of asset structuring. Further, for lawyers to be allowed to describe themselves as accredited specialists in an area of law, takes even more training and experience. Whilst some asset protection consultants may have relevant qualifications or experience, there is no minimum standard of training or professional body which supervises them. Some of these so-called specialists have no more than a couple of days training at an investment guru’s seminar.
• Secondly, despite the numerous (and often quite amusing) jokes about greedy lawyers, lawyers are required to operate in an ethical manner and can lose their right to work if they fail to do so. Asset protection consultants are not a regulated professional body.
• Thirdly, and perhaps most importantly, both accountants and lawyers are required by law to carry insurance, so if they do get it wrong, there is an insurance fund you can make a claim against to try to recover your loss. There is no requirement for an asset protection consultant to hold professional indemnity insurance.

 

Where’s the value-add?

Where’s the value-add?

Achieving the best asset protection outcome involves analysis of a complex web of different laws. One must consider: personal and corporate insolvency legislation; company and trust law; insurance; stamp duty; land tax; income tax (including capital gains tax) laws. Also, structuring decisions can only be made after a detailed analysis of the business and personal circumstances of the investor involved. Consideration of their objectives is required – in relation to issues such as the nature, scope and funding of their current and proposed investments, costs (both initial and ongoing), tax-effectiveness and efficiency, simplicity and flexibility. Often, the structure or combination of asset holding structures which an investor implements, will involve a degree of compromise between these objectives.

The asset protection consultants I spoke to were all quick to point out that all the “technical stuff” was dealt with by the guru’s advisers. So my question is – why do you need an asset protection consultant at all? The consultant can’t provide you with any legal or tax advice for a fee – to do so would be a breach of the law. So exactly what value do they provide? It seems they provide some marketing under the guise of “education” and then merely act as go-between and take a fee or kickback for doing so. Rest assured you’ll be paying for the consultant’s time somewhere! If your lawyer or accountant isn’t providing you the level of service and explanation you want, tell them so. But please don’t fall for this form of two-tiered marketing offered by asset protection consultants when that value should be coming from your adviser in the first instance.

To be fair, most of the asset protection consultants I’ve spoken to are good, honest people just trying to earn some extra income. The explosion of asset protection consultants seems to have been driven by a number of investment gurus who are promoting this as a form of network/multi-level marketing business. The consultants I’ve spoken with are from diverse backgrounds, such as allied health practitioners and small business people. They have quite rightly decided that asset protection is an important issue for investors and want to spread the “good word”. They have typically paid a not inconsiderable fee to attend a training course run over several days by the relevant investment guru and his team of legal and accounting advisers. The consultants then receive some ongoing training updates and set scripts for their marketing letters, websites, recorded messages and personal interviews. The upside for the consultant, in addition to the warm inner glow of helping others, is that they are paid a referral fee by the investment guru and his advisers if the investor then deals with those parties to establish his or her asset protection structures.

So it’s a nice little referral business from which the consultant can get some semi-passive income by acting as a go-between and “viral marketer” for the guru and his team. The problem is that these consultants, whilst well-intentioned, are dangerously underqualified and they market their services in what to my mind is a morally dubious way, that overemphasises the risks. To draw a medical analogy, let’s say you found out you needed major surgery. You’d certainly talk to friends and relatives who had experienced that type of surgery, and perhaps the hospital education officer, but you’d run a mile if anyone but your expert surgeon picked up the scalpel!

In summary then, asset protection is an important issue for investors, but as the Hitchhikers Guide to Galaxy cautions: Don’t Panic! [note=1]Adams, D. The Hitchhikers Guide to the Galaxy, (1979) Pan Books, London, p 2 [/note]. Instead, ignore the fear tactics promoted by these asset protection consultants and see your lawyer or accountant for a calm, rational and informed analysis of the risks you face and your options to manage those risks.

 

The facts about litigation in Australia

The facts about litigation in Australia

In recent years there have been many newspaper and media reports about the supposedly increasing numbers of lawsuits in Australia. The fear is that we will end up with an American style litigation culture where people bring frivolous claims and get massive awards of damages. Indeed these two assumptions seem to form a central theme of the asset protection consultant’s marketing campaign.

Forget the beat up - time for a dose of reality. Unfortunately there is a lack of comprehensive and current evidence about changes in the frequency and amount of claims in Australian courts and the size of damages awarded. However, a 2002 report which used data from court registries in four states and the ACT found that overall levels of litigation were decreasing in those jurisdictions [note=2]Australian Health Ministers Advisory Council Legal Process Reform Group, Responding to the Medical Indemnity Crisis: An Integrated Reform Package, (2002).[/note].

Further, in 2002 the Federal Treasury commissioned respected risk consultants Trowbridge Consulting (which has since merged with Deloitte), to analyse statistics from Insurance Statistics Australia. They investigated claims under insurance contracts, which have a strong correlation with the potential number of incidents, and which can give rise to lawsuits.

The report concluded that the number of insurance claims made in Australia slightly decreased in 1999 and 2000 and were relatively uniform in the years from 1993 to 1999 [note=3]Trowbridge Consulting, Public Liability Insurance – analysis for a meeting of Ministers 27 March 2002, (26 March 2002).[/note]. Although both these studies are now a little dated it seems that the view that litigation in Australia is on the increase is not supported by the statistical data we do have.

The second point about the great excesses of damages awarded by the United States court system is also unfounded. The US courts do not permit unrestricted liability in negligence any more than Australian courts do. Liability in the US is restricted by the need to prove that the defendant was guilty of negligence and for that negligence to be the cause of the injury or loss suffered by the person bringing the claim – just as it is here in Australia.

That’s all very well you say, but if litigation isn’t increasing: why have my insurance premiums increased over the last few years? That’s a fair question. I suspect the reasons that insurance companies increase premiums are driven by the same economic imperatives as other businesses – namely supply and demand. However, anecdotal evidence from those in the insurance industry suggests that two events have been significant contributors to the increased cost of public liability insurance in Australia.

Firstly, the collapse of HIH in early 2001 and second, the terrorist attacks on 11 September 2001. Another potential factor behind premium rises is the cyclical nature of insurance markets. Historically premiums have remained stable or fallen for extended periods with short periods of rapid increases between those longer periods [note=4]Ibid.[/note].

Summary so far

Whilst we can all be amused by those TV shows, websites and emails which focus on ridiculous claims being made in courts – US courts in particular – please bear in mind that these are generally isolated incidents, claims made by unfortunate plaintiffs representing themselves who have no chance of winning the amount they are claiming, imaginary cases from the latest LA Law clone TV show or just plain urban myths. While you do need to take prudent steps to protect your assets, there’s no cause to be unduly alarmed about packs of avaricious litigants waiting to pounce on you with unjustified lawsuits.

The logical questions which follow are:

• What exactly is asset protection?
• How do I figure out if I need asset protection?
• If I need asset protection, how can I achieve it?

The answer to any one of those questions could fill volumes, so in this article we’re merely outlining some of the key points. This should provide you with a framework to start filling in the detail of your knowledge about investment structuring in later InvestEd resources.

 

What is asset protection?

What is asset protection?

Asset protection is simply the process of protecting your investments from being taken away without your permission. The means by which asset protection can be accomplished vary with the circumstances of the investor and their preferences and other objectives. In many cases the best way to achieve asset protection is through the establishment of legal entities such as companies, or legal relationships such as trusts, within which to hold our investments. Interposing these ownership structures creates a form of separation between us and our investment assets. The concept of separation is one the key ideas we will explore in this article.

How do I know if I need asset protection?

Risk analysis within a financial planning framework

The cause of a third party trying to claim your assets can arise from a variety of different sources. Broadly speaking the sources of risk can be categorised into either: risks related to you, or risks related to the nature of your assets.

Risks arising from everyday living

Sources of risk related to you include:

• Occupation: In some jobs, particularly those where you provide services or give advice or treatment to “customers” (eg accountants, architects, lawyers and the various types of medical practitioners) you are more likely to get sued by disgruntled clients than in other occupations. The risk is particularly acute for the self-employed. For investors whose “day job” is in one of these recognised “at-risk” occupations, appropriate asset protection is essential.
• Things you say or write: Sometimes our big mouths can get us into trouble. With the proliferation of email, discussion forums and web blogs, more so than ever we can inadvertently expose ourselves to claims that we have defamed someone.
• Your relationships: Sadly not all romances end happily ever after. The financial toll can be just as high as the emotional one. Whilst the Family Court has a long reach, and de facto spouses now have greater rights today than ever before, there are some steps you can take to limit your exposure to claims from your “ex”. Also, asset protection concerns don’t end when you die. The final stage in asset protection is to make sure your assets are passed to the people you want to receive them. Family members who feel they have been unfairly “cut out of the will” can bring claims against your estate and potentially defeat your wishes after you’re gone.
• Accidents: Whilst we all try to drive safely, accidents happen. Admittedly, insurance has a major role in shifting the financial risk of accidents. However, insurers can decline payment in some circumstances.
• Offices you hold: If you are director of a company or even on the committee of your local sporting club, you expose yourself to risk of litigation, particularly in the event of financial problems with the company or club. Even if you’re not directly involved, the mere fact you are an officeholder can lead to potential liability. Again insurance (directors and officers in this case) has a part to play, but may not be fully effective.

Risk arising from your assets

• Direct real estate: If a tenant has an accident in your investment property, they may seek to claim that it was caused by some defect in the repair or condition of the property.
• Business: Running a business can be the path to considerable wealth. However it also brings with it a whole raft of responsibility and risk. These risks arise out of obligations to financiers, employees, creditors (including the Tax Office) and customers. A failure to meet those obligations can lead to legal claims against the business owner. Depending upon the structure used to own and operate the business, your investment assets can be exposed to claims which arise due to your business dealings.

 

An integrated approach to asset protection planning

An integrated approach to asset protection planning

As noted earlier, asset protection planning cannot be considered in isolation from your current circumstances and wealth accumulation goals. Instead it should form part of a structured analysis and evaluation process which fits within your broader financial plan preparation.

The conceptual model for financial planning is a useful discipline to apply here regardless of whether or not you are going through the planning process with the assistance of a financial planner. There are 6 stages to the traditional model, which are described below along with an outline of what’s involved in each step from an asset protection perspective.

1. Information gathering

This is where you gather the information and assess your current financial position. It’s a good chance to do a financial and risk audit.

This is the stage at which you need to flag the obvious sources of potential risk to your wealth. As noted above, this would include considering whether you are at risk of being sued from your occupation and whether your investments expose you to any risk of claims. There may be avenues of risk which don’t immediately occur to you – but don’t be too concerned up front, in discussing your circumstances with your adviser these should be flushed out.

2. Identify your goals

Identifying your short, medium and long term financial and lifestyle needs and objectives, i.e. where do you want to go and what do you want to be doing in the future? This should not be restricted to purely financial considerations. Investment is not an end in itself, merely the means by which you fund the lifestyle you desire.

3. Develop a strategy

This is where many people actually start, e.g. “I’ll do wraps for cash flow and buy and holds for growth”. You are short-changing yourself if you don’t step back and go through the first two steps. Your strategy will, in part, determine your asset protection needs. For example, if you’re plan is only to invest in ASX listed shares and property trusts and will never borrow to invest, then it may well be that a single family trust is your best option.

4. Plan preparation

This is the process of formally documenting the strategy and some of the tactical steps required to implement it. For example, if like most people, your strategy will involve you funding the purchase of investment properties largely with borrowed money then you will need to consider appropriate insurance arrangements to make sure the debt can be serviced and repaid if you die or are unable to work for an extended period.

This is where you should consult with your legal and accounting advisers to identify the best structures to achieve your goals whilst using various asset protection techniques to keep your risk at a level which is acceptable to you.

5. Implementation

The first stage of this step will be to establish any structures, such as companies and trusts, which have been identified in the planning process as your preferred investment vehicles.

The second stage is to acquire assets and hold them over time within the relevant structure to achieve your investment objectives of income and growth.

6. Monitoring and review

Just as you must keep an eye on the performance of your investments you should also on a regular basis review and fine tune the performance and effectiveness of your asset protection strategy with your advisers.

 

How do I protect my assets?

How do I protect my assets?

Key principles for choosing the right investment structure

As you learn about the various asset protection options available to you, including partnerships, companies, various types of trust, including self managed superannuation funds and combinations of these structures, it is easy to feel overwhelmed by the various features and drawbacks offered by each. Faced with these bewildering choices it is important to remember the KISS principle – “keep it simple, stupid”! Expensive and complex is not necessarily better when it comes to choosing your investment vehicles.

A detailed evaluation of the pros and cons of the different investment ownership and asset protection structures available is beyond the scope of this article. Rather than get tied up in the details at this stage, the best course is to have a list of criteria against which you can evaluate the various options which your adviser may provide.
When evaluating various structuring options and choosing between them, investors should aim for a solution which is:

• Simple – If you don’t understand how you own or control your assets it will invariably cost you money. Either you will do something that unintentionally incurs stamp duty or capital gains tax or, less disastrously, merely fail to extract all the potential advantages from your investment structure. Whilst some arrangements are by their very nature more complicated than others, the guiding principle here is to avoid unnecessary complexity.
• Efficient – The goal of any investment structure should be to ensure that at the right time, the right people receive as much of the available money from an investment as possible. The tax system, at both the federal and state level, can make some methods of wealth creation and distribution more costly than others. It is a discussion we will need to leave for another day, but rest assured that there are considerable and completely legal tax advantages offered by some structures. Accordingly, investors should favour an investment structure which allows them to operate in the most tax efficient manner which the law permits.
• Cost-effective – elaborate structures will cost more to establish, requiring specialised legal and accounting advice, and will have higher ongoing administrative, auditing and compliance costs. Whilst investors should take a long-term view about the benefits to be gained from implementing a particular investment structure, (some of which are not quantifiable), these must be weighed against the initial and ongoing costs associated with such structures. For example, an analysis of auditing and compliance costs against the benefit of control over investments is often cited as the reason why people with relatively small superannuation balances should not implement a self managed fund.
• Protective – There’s not much point in accumulating wealth if you can’t hang onto it. Some methods of owning or controlling assets are more vulnerable to external scrutiny and attack than others. It follows that in evaluating the level of protection implemented through utilising different investment structures and other risk mitigation strategies should be commensurate with the investor’s risk level. Even if you own your investment properties in your own name, there are some asset protection “tricks” you can use to make it more difficult for third parties to access them.
• Flexible – People’s circumstances constantly change: families grow and shrink in number, incomes vary from year to year, people retire and financial needs vary over time. The best investment structure for you will be one that provides the maximum degree of flexibility to cope with these changing circumstances. Of all the principles to bear in mind, this is perhaps the most important. The only certainty we have (apart from death and taxes) is that both your circumstances and the law relating to tax and asset protection will change.

 

Summary

Summary

In part one, we examined the regrettable phenomenon of “asset protection consultants” and concluded that these so-called specialists generally add little or no value to your asset protection planning. We also looked at the facts, such as they are available, in relation to litigation in Australia and concluded that whilst we need to be aware of the potential for lawsuits, there’s no evidence they are an increasing risk for investors. Finally, in this part we provided an outline of some potential sources of risk for investors and then looked at the key criteria for evaluating any proposed asset protection structures under consideration. At the end of the day, if you plan to accumulate considerable wealth, which should of course be your goal as an investor, you need appropriate asset protection structures. But those structures should be implemented only after a rational and informed evaluation of your risks and options, in conjunction with your qualified legal and financial advisers.

See also

• Discussion about this article
• Accounting, Tax and Legal articles
• Accounting, Tax and Legal discussion forum
• Investing Book reviews
• Glossary of Investing Terms