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Legal Matters
The Necessity of “Asset-Protected” Investments
In these uncertain times, be careful not to leave your assets
vulnerable to malpractice judgments.
By Jason M. O’Dell, Stan Miller, JD, and David B. Mandell, JD, MBA
We have been helping the medical community shield assets from potential lawsuits
for years. While we often establish sophisticated trusts, limited partnerships,
captive insurance companies, and even offshore arrangements to protect our
clients’ assets and help them save taxes, often we need not be that creative.
In many states, the law gives us tremendous opportunities to protect wealth and
lessen income taxes—through life insurance vehicles and annuities. If shielding your net worth from
a potential lawsuit is important to you—and if you would like to pay less in income taxes—you must consider these tools as part of your financial plan. The question then
becomes: if you have a choice between two fairly equal investments, why not use the one
that is asset-protected and enjoys special tax treatment under the law? The
wise choice is to make use of the asset-protected, tax-deferred investment. Let’s see how that works.
State law protects certain investments
Every state has laws that shield certain assets from creditors. These are called
“exempt assets,” as they are exempt from seizure in a lawsuit or in bankruptcy. What types of
assets are afforded this protection? Most common are the IRA (only in some
states) and a portion of the primary residence through what is called a “homestead exemption.” Also protected in many states are life insurance policies and annuity
contracts.
When we refer to life insurance policies here, we mean “cash value” policies or what is called “permanent insurance.” Unlike term insurance, which just provides death benefit, these types of
policies have a cash account, which are not limited size. You conceivably could
have life insurance policies that have hundreds of thousands, if not millions,
of dollars in cash account value and still enjoy all of the asset protection
and tax-deferral benefits under the law. Whole life, variable life, universal
life and variable universal life—these are all types of cash value insurance. Under tax law, the growth in these
policies builds up tax-free. Also, withdrawals and policy loans can be taken
against the cash account tax-free as well. Thus, cash value life insurance
enjoys superior tax treatment as compared to any other liquid investment
(stocks, bonds, CDs, etc.).
Life insurance: protected everywhere
All 50 states have laws protecting life insurance, but they each protect
differing amounts. Some general trends:
• Most states shield the entire policy proceeds from the creditors of the
policyholder. Some also protect against the beneficiaries’ creditors.
• States that do not protect the entire policy’s proceeds set amounts above which the creditor can take proceeds. For example,
Arizona exempts the first $20,000 of proceeds.
• Many states protect the policy proceeds only if the policy beneficiaries are
the policyholder’s spouse, children, or other dependents.
• Most states also exempt term and group life policies.
• Some states protect a policy’s cash surrender value in addition to the policy proceeds. If you have
substantial cash value in a life insurance policy, be sure to consult your
state exemptions.
Annuities are shielded in many states
There are two types of annuities—variable annuities and life annuities. Variable annuities are insurance
contracts that invest the contributions into investment vehicles on a
tax-deferred basis. A life annuity is an insurance contract where the investor
pays a certain amount of money up-front and the insurance company then pays the
investor back at a fixed payment every month, quarter, or year for as long as
the investor (or spouse) is alive. Many, but not most, states protect annuities
from creditor claims. In the states that do exempt them, annuities are an ideal
tool to safeguard wealth. Let’s consider an example:
Case Study: Sam chooses between mutual funds and a variable annuity
Sam is a radiologist concerned about asset protection, as he has seen a number
of malpractice judgments financially cripple physicians in his medical
community. Sam now has $50,000 to invest and is in a state where variable
annuities are protected. His decision is whether to invest the money in mutual
funds or in a variable annuity. He knows that annuities have higher charges
than mutual funds. However, for that higher expense, Sam would enjoy tax
deferral and asset protection. Let’s assume that the difference in charges is about 1.5 percent annually. Is it
worth it for Sam to use the annuity when it is protected and grows tax-deferred
rather than the mutual fund? We can’t say for sure without knowing more about Sam’s goals and portfolio, but ask yourself the question: would you pay an extra
$750 per year to protect that $50,000 from all potential lawsuits and grow
those funds tax-free?
If asset protection and tax reduction are important to you, you need to speak
with an asset protection expert familiar with the laws and cases in your state.
Once you do, you will have a better idea of how such investment options should
be optimized in your comprehensive financial plan.
Be aware of asset protection
As attorneys to hundreds of physicians, we encounter many misconceptions about
asset protection planning everyday. The most important of all these
misconceptions: that this area of planning is not important, because physicians don’t lose assets to medical malpractice lawsuits. The thinking of many physicians
around the country, and unfortunately their advisors as well, is that there is
little to any risk of a physician losing their personal assets in a malpractice
claim, especially if there is the typical $1 million per occurrence $3 million
per year malpractice insurance coverage. There are a number of key issues in
this analysis to review. We will take each one individually:
Finding proper data is difficult
We, the authors, are not people who use extremes. We like to see data before
making judgments or forming opinions. However, tracking how many physicians
have lost personal assets in malpractice actions is very difficult. This is
because the legal system publishes filed cases and judgments rendered, but does
not publish the collections of those judgments.
There are no reporters that publish what happens once a judgment is rendered.
Did the plaintiff, with a judgment in excess of coverage limits, simply settle
for the amount of the medical malpractice insurance? Did the plaintiff and his
attorney pursue the personal assets of the physician and his family to satisfy
any excess judgments? These are questions for which there are no answers in the
published materials.
Every week in the malpractice reporters we review, there are dozens of
malpractice actions decided in the states in which we practice. Most decisions
are for the physician defendant, some are small judgments for the plaintiff and
a few, every week, are very large judgments for the plaintiff. It seems that
many physicians and their advisors simply assume that their plaintiffs in these
cases will walk away from very large judgments and simple settle for the
malpractice insurance coverage. Let’s look at a couple of reasons why this may not be so.
Payments, not evictions
A common theme in speaking to physicians and their advisors on this topic seems
to be that “I have never personally heard of anyone losing their home to a lawsuit,” and therefore the conclusion is that it doesn’t happen. If one understands the goal of litigation and the plaintiffs, however,
this certainly isn’t surprising. What does occur instead of an eviction, is that the plaintiff with
the judgment will file a lien on real estate, levy bank accounts, or put liens
on them and essentially put levies or liens on any assets of the physicians to
the amount of the judgment owed to them. The goal is not to kick the physician
out of their home, but make the doctor take a loan against the home to pay off
the excess judgment. And this, we can assure you, happens with regularity.
Case study: David’s client in New York
A couple came to visit David to review their asset protection situation. The
husband was a cardiologist and wife was an OB/GYN. The wife had just been
successfully sued for a bad baby case in which the judgment rendered against
her was $4 million. That was $2 million more than her personal malpractice
coverage limit. The plaintiffs have a legal right to collect $2 million from
this doctor after the malpractice insurance pays.
If you consider that the plaintiff’s attorney is entitled to 33 percent of everything collected, do you think the
attorney will walk away from the other $2 million just because it isn’t in the form of a malpractice policy payout? Would you walk away quietly from a
million dollars that you have every right to claim? It doesn’t cost the plaintiff anything to instruct the attorney to pursue every remedy
possible to collect the rest of the judgment. The attorneys could put a lien on
the $1.5 million of equity in the defendant’s home in a matter of two hours with the cost to the attorney being about $500.
It is completely irresponsible to assume that your assets are protected simply
because you don’t know anyone who has lost a home or other personal assets.
The legal obligation of the plaintiff attorney: Get the cash
There seems to be an underlying assumption (by attorneys who advise doctors that
asset protection isn’t important) that plaintiffs and their attorneys will not go after physicians’ personal assets because it is “distasteful” or for some other reason. But put yourself in the shoes of the plaintiff and
his or her attorney. The plaintiff’s attorney has a professional and ethical obligation to represent his or her
client with their best interest to the fullest extent of the law. Let’s say, as an attorney, I represented a plaintiff who had a $4 million judgment
and only $2 million was paid by insurance. If I knew that the defendant had millions of dollars of assets which were
unprotected that I could attack in order to get my client paid in full, I would
have to do this.
It is a fairy tale that plaintiffs and attorneys won’t go after physicians’ assets because of some kind of ethical consideration. Pair that fairy tale with
the fact that there are, in fact, ethical rules requiring an attorney to go
after such assets, and you can understand why the advice “you don’t need asset protection” is so off base.
Why would you protect assets?
Even with all the statements that we made in this article, it is still
statistically relatively low risk that you will lose personal assets in a
malpractice action. The point that we make with our clients and in our books
and articles, however, is that asset protection planning can actually benefit
you in many ways beyond lawsuit protection.
In fact, most of the asset protection we do for clients is relatively low cost
and has numerous financial, tax and estate planning benefits as well. Thus, the
question becomes “if asset protection planning can protect you in many ways and the cost is
relatively inexpensive, why wouldn’t you do it—when there is even a slight chance that you will lose personal asset at some
time during your career?”
Asset protection planning is a crucial part of a client’s financial planning. It is no more important for any group in America than it
is for physicians. Everyone acknowledges that there is some risk of a
beyond-insurance limits lawsuit for any doctor. If this is true, and proper
asset protection may actually help you BUILD wealth, then such planning cannot
be ignored. UO
Jason O’Dell is a financial consultant and author of Financial Planning for Physicians:
Strategies for Saving Money and Securing your Financial Future. Stan Miller is
an attorney and principal of a national network of attorneys, WealthCounsel.
David B. Mandell, JD, MBA is an attorney, lecturer, and author of the books The
Doctor’s Wealth Protection Guide and Wealth Protection, M.D. To reach Jason, Stan, or David, please call 800-554-7233.
