Excerpted from The Biggest Legal Mistakes Physicians Make: And How to Avoid Them
Edited by Steven Babitsky, Esq. and James J. Mangraviti, Esq. (©2005 SEAK, Inc.)
Download Free 646 Page E-book: The Biggest Legal Mistakes Physicians Make and How to Avoid Them
Executive Summary
All states provide some degree of asset protection through their state exemption laws. Many physicians attempt to implement asset protection on their own by using state exemption laws that shield certain types of assets, such as a homestead, wages, annuities, life insurance, and retirement funds. In doing so, physicians often invest in assets that provide neither the maximum return nor the optimum asset protection. In addition, investments in exempt assets are often made without proper estate tax considerations. Therefore, physicians need to proceed with caution and seek experienced advice before attempting to utilize state exemption laws.
Mistake 1 Not Getting Advice of Experienced Counsel Before Attempting to Use a State Exemption
Physicians often attempt to use the creditor exemption laws of the state in which they reside in a way that does not always provide the desired exemption. As a result, they may expose their assets to more liabilities than anticipated, and they may receive no or less protection from third-party claims than could otherwise be obtained. In addition, using state exemptions sometimes causes physicians to forgo other investment opportunities with greater appreciation potential. Obtaining competent legal counsel will result in greater protection of assets with less exposure to liabilities and headaches, as well as provide flexible estate planning.
Action Step Physicians should consult with legal counsel who has knowledge of the exemption laws and the options available in using them.
Mistake 2 Not Knowing the Exemption Laws That Apply to the State of Current Residence
Some assertions should not be taken as gospel, such as a statement about the protection afforded by putting assets in a spouse’s name or by titling assets jointly with a spouse. The state in which a physician resides (or the state in which a physician’s real property is located) may not afford the same protection as the protection afforded by other states. A physician needs to know which state is his or her primary residence for purposes of litigation (it may not be the same as the state in which the physician has an office). In addition, a physician needs to know what exemptions are available for residents of the state and to what extent those exemptions are available to the physician given the specific circumstances. For example, Massachusetts provides generous homestead protection to people over a certain age or with a disability. Since real property is governed by the laws of the state in which it is located, if the physician (or a trust) owns property outside his or her state of residence, the physician will need to know what if any protections are available in that state for the real property. However, the physician must also remember that when real property is owned by an entity (e.g., a limited partnership, a limited liability company, or a corporation), other laws may apply, and homestead exemptions may not be available.
Action Step Physicians need to have a qualified professional periodically review their assets to ensure those assets are held in a manner providing the best protection for the physicians.
Mistake 3 Attempting to Convert a Nonexempt Asset into an Exempt Asset at the Wrong Time
Physicians sometimes attempt to protect their assets after the threat of a claim occurs by converting nonexempt assets into exempt assets. An exemption from attachment, garnishment, or legal process provided by a state’s statute would not be effective if the physician fraudulently transferred or converted the asset. Any conversion by the physician that results in the proceeds of the asset becoming exempt by state law from the claims of a creditor of the physician may be a fraudulent asset conversion as to the creditor—whether the creditor’s claim arose before or after the conversion of the asset—if the debtor-physician made the conversion with the intent to hinder, delay, or defeat the claim of the creditor. In other words, a court can order the transfer/conversion to be undone, and thus make the asset available to the creditor.
Action Step Asset protection planning should be undertaken (and completed) before there is any claim against the physician.
Mistake 4 Moving One’s Principal Residence from One State to Another
People often relocate from one state to another. After they move, they often forget to have their wills redone and their asset holdings reviewed in light of the laws of their new state of residence. For example, a physician moving to Florida from Delaware (which has no homestead protection) may fail to take advantage of the generous homestead (unlimited value) protection afforded in Florida for a physician’s primary residence. Conversely, moving may cause the loss of protection. For example, Florida provides a 100% wage exemption for the head of a family, whereas Georgia limits it to 75%. Thus, a physician who is the head of a family and moves his practice from northern Florida to Georgia may not realize that his wages have lost substantial protection. Primary residence is also relevant when IRAs, SEP/IRAs, and 509 plans are involved. Plans that are not “ERISA qualified plans” are protected by statute in some states (such as Florida, Kansas, New York, and Wisconsin). Whether and to what extent a physician’s non-ERISA plan is protected must be determined by reviewing the applicable state law. Physicians who move from a state that protects IRAs to a state that does not lose the protection for their IRAs.
Action Step Before they move their residence to another state, physicians should seek counsel from an attorney familiar with the exemption laws of the intended state of residence.
Mistake 5 Losing the Exemption by Titling the Asset Improperly
Just because a physician owns an asset that is eligible for exemption under state law does not make the asset automatically exempt; it must be titled in the specific manner to allow the physician to claim the exemption. For example, state law may provide a homestead exemption that makes all or part of the physician’s primary residence in the state exempt from the physician’s creditors. Generally, only a natural person (i.e., a human being) may claim homestead protection, and that natural person must have legal title to the property. Thus, if the physician’s principal residence is owned by a limited liability company, a limited partnership, a corporation, or a trust, the physician may lose the exemption. For example, a physician’s home in Florida would be 100% exempt from the claims of his or her creditors. If the physician places the home in a family limited partnership, the homestead protection would be lost and a creditor may have a way to reach the otherwise exempt asset.
Action Step Physicians should have the manner in which their assets are titled reviewed by competent counsel to ensure that they are receiving the maximum protection from available exemptions.
Mistake 6 Relying on a State Exemption When Other Investment Properties or Vehicles Would Better Suit Physicians’ Goals for Asset Protection, Estate Planning, and Investing
Physicians residing in states that provide a generous homestead protection from creditors often invest a substantial portion of their wealth in a residence. Often, they do not realize that the state statute protects only the actual primary residence in the state in which they reside such that their second home is fully exposed to creditor claims. Also, homestead exemptions typically cover the actual residence, not the contents, such as furnishings. In Florida, for example, a physician may have unlimited value protection for the actual residence (assuming that it is on one-half acre or less in a municipality), but only $1,000 of the physician’s furnishings are protected. Also, putting an inordinate proportion of one’s net worth in a primary residence results in the loss of other investment opportunities. The real estate market is not always the best investment vehicle.
Action Step Before taking advantage of an exemption, physicians should have an experienced professional clearly explain the drawbacks and limitations of the exemption.
Mistake 7 Using Life Insurance or Annuity Contracts As a Primary Investment or an Asset Protection Vehicle
In states providing life insurance or annuity exemptions, physicians often place a disproportionate amount of their net worth in such vehicles. Life insurance policies and annuity contracts are often marketed as a method of investing assets with protection from creditors. Physicians do not weigh and are often unaware of the hidden costs of such vehicles in terms of built-in commissions, termination fees, and limited investment offerings (usually restricted to a limited number of mutual funds), as well as their inflexibility when compared with other protective vehicles, such as properly implemented asset protection trusts or properly implemented asset protection trusts in combination with limited liability companies. In addition, any investment or premium payment made once the threat of a claim exists is subject to attack on fraudulent transfer grounds and may be undone by a court.
The availability and the extent of the exemption with respect to the cash value of life insurance during a physician’s life vary widely among the states; the exemption is limited to $4,000 of cash value in bankruptcy where the federal exemptions apply. Although some states (e.g., Florida, New Jersey, and New York) provide a more generous exemption, further protection for the insurance may be available by transferring ownership of the insurance to an irrevocable insurance trust, a limited partnership, or a limited liability company. Each provides additional impediments to creditors, such as spendthrift clauses and charging order limitations, which can usually be used for estate planning purposes as a means of removing the assets from the physician’s estate. If, however, a life insurance trust is used, it should be in place (in other words, fully executed) before the policy is acquired, and the policy should be acquired by the trust directly. Also, if premiums are paid after a claim is asserted, the creditor may be able to recover the premiums paid.
Action Step Before physicians commit a substantial portion of their assets to an annuity or life insurance trust, they should consult an experienced asset protection professional.
Mistake 8 Placing Title to a Physician’s Life Insurance Policy in a Spouse, Children, or Other Family Members
Physicians often attempt to protect their family members by purchasing life insurance and making the spouse, a child, or other family member the owner of the policy. In states where life insurance is exempt, it is generally exempt from the creditors of the insured not the creditors of the owner. Thus, placing policy ownership in the name of the spouse, a child, or another family member exposes the policy to the claims of such family member’s creditors. In addition, transferring title raises gift and estate tax issues. Instead, if the physician has a life insurance trust purchase the policy initially or own it for three years before the death of the insured (physician), the insurance death benefit will not be included in the physician’s estate and the death benefit will escape estate taxes.
Action Step Physicians should not transfer ownership of their life insurance policies to their spouse, children, or other family members; rather they should have their attorney prepare a life insurance trust to purchase the life insurance policy (or to hold existing life insurance policies).
Mistake 9 Purchasing or Owning a Life Insurance Policy on One’s Own Life and Making One’s Estate the Beneficiary
A state exemption law may protect only the death proceeds of a life insurance policy that are not payable to the physician’s estate (or a trust obligated for the deceased physician’s debts) from the creditors of the insured. A few states also protect the proceeds from the creditors of the beneficiaries. If the physician’s estate is the beneficiary of his or her life insurance policy, the policy proceeds will be available to the creditors of the physician’s estate and be included in the physician’s estate for the purpose of determining the gross taxable estate for estate tax purposes. On the other hand, if the physician has his or her life insurance trust purchase a life insurance policy on the physician’s life and makes the trust the beneficiary, then the death proceeds would not be included in the estate and would not be reachable by the creditors of the physician’s estate. If the physician already owns a life insurance policy on his or her life and transfers ownership to a life insurance trust (and does not have the estate named as the beneficiary), the physician must survive three years from the transfer for the death benefit to be excluded from his or her estate for estate tax purposes.
Action Step A physician must be sure not to purchase or own life insurance directly. Life insurance policies should be purchased and owned by a life insurance trust and a physician’s estate should never be a beneficiary of the policy.
Mistake 10 Relying on Tax-Qualified Retirement Vehicles in Order to Be Protected from the Claims of Creditors
Lower courts have chipped away at guaranteed protection, creating exceptions and limitations to the protection of tax-qualified retirement plans. One court has even stated that it was not bound by the fact that the IRS had determined a plan to be qualified and that the court could take a hindsight look at qualification. The pension benefits of physicians who work for a large entity and do not own a controlling interest in it are probably protected. However, the pension benefits of physicians who are owners of, or partners or shareholders in, a practice may not be protected.
Physicians should take matters into their own hands. Following the asset protection rule of “removing the ability of any U.S. court to disrupt the physician’s planning,” protecting retirement plan assets can be accomplished by causing the retirement plan to establish a single-member offshore limited liability company (an LLC) governed by properly structured documents containing special protective provisions. The retirement plan contributes (transfers) all of its assets to the LLC in exchange for a 100% ownership interest (member interest) in the LLC, leaving the plan directly holding only a member interest in the offshore LLC. As long as no significant litigation threat exists, the LLC assets can continue to be held at the same U.S. financial institutions in which they previously resided, managed by the same investment adviser, and the trustee of the pension plan (probably the physician) can be the LLC co-manager and have direct signature control over the cash and securities as before. If a creditor seeks to reach the retirement plan assets, the offshore co-manager of the LLC would, pursuant to the LLC operating agreement, remove the U.S. co-manager and relocate the LLC assets to a suitable offshore financial institution, identified beforehand with the assistance of experienced counsel. At this point, the retirement plan assets would be held at an offshore financial institution, but they would remain invested in the same securities and managed by the same investment adviser as they were before. A U.S. court could not force the LLC owner (the retirement plan) to turn over the LLC assets because the offshore LLC manager (now in control of the assets) is permitted to act only when the LLC owner (the retirement plan) is giving directions voluntarily—without any U.S. court interference.
Action Step To be certain that their qualified retirement plan assets will be available for retirement enjoyment, physicians should not depend on a U.S. court to follow the letter of the law. Rather, they should get competent, experienced counsel and protect their assets.
Conclusion
Physicians seeking to protect their assets who are mindful of these mistakes and take steps to avoid them will be most likely to achieve the desired protection for their assets.
Additional Resources
- Donlevy-Rosen & Rosen, “Special Protective Measures Required: For Retirement Plans, Real Estate, and Accounts Receivable,” The Asset Protection News, Vol. 11, No. 3 (Nov. 2002); http://protectyou.com/apn11-3.html
- P. Donlevy-Rosen, RIA, Tax Advisors Planning Title 32: Asset Protection Planning (available only to RIA subscribers)
- H. Rosen, “Sheltering Your Retirement Assets From Creditors,” Physicians Financial News (March 15, 2003); www.protectyou.com/PhysiciansFinancialNews3-15-03.pdf
- H. Rosen, “Offshore Trusts Can Create Legal Obstacle Course for Claimants,”
Medical Business (June 1996); www.protectyou.com/MED_BUS.html - www.ProtectYou.com (website authored and maintained by Donlevy-Rosen & Rosen, PA, a law firm in Coral Gables (Miami), Fla.)
Written by:
Patricia Donlevy-Rosen, Esq.
Peer reviewed by:
Howard D. Rosen, Esq.