Can They Take My Retirement? Basic Asset Protection Explained

Over time we accumulate assets. We borrow money to buy a home and repay it. The home usually appreciates in value (except for recently). Some of us buy CDs or stocks, bonds, and life insurance. Or we contribute to an individual retirement account (IRA) or a 401k.  

These assets can be protected from creditors to some extent.      

The foremost way to protect assets from creditors is to avoid liability in the first place. Being careful, conscientious, and honest is a great way to not get sued.  

Sometimes bad things happen, even to good people. Carrying adequate liability insurance is the next line of protection. An umbrella policy provides coverage above and beyond the typical auto and homeowners policies. Service professionals – like doctors and lawyers – are well advised to carry malpractice insurance.

Separating personal and business affairs is another way to protect oneself. Forming a corporation or limited liability company around the business can prevent a business debt from becoming a personal debt.

Well-structured assets is the next and last line of defense. This is where things can get complicated.  

Before suing someone, a plaintiff asks, “if I win my lawsuit, will I get paid?” After all, a court judgment is just a piece of paper, but it can be enforced by taking the debtor’s assets and selling them to pay the judgment.  

Here is the key: Not all assets can be taken. Only non-exempt assets may be used to satisfy a judgment. By maximizing one’s exempt assets, to the disfavor of non-exempt assets, there is less for a creditor to take. This can discourage a plaintiff from filing a lawsuit in the first place.

One example of an exempt asset is the homestead – or at least, part of it anyway. In Washington State, the first $125,000 of equity in one’s home is exempt from creditors. This is commonly known as the homestead exemption.  Other states have lower homestead exemptions, and some have unlimited exemptions. 

The “equity” is calculated by adding up all the mortgages on the home and subtracting that amount from the distressed sale value of the home. (The “distressed sale value” is the amount it would sell at a foreclosure auction.) If that amount is less than $125,000, a creditor will not be able to take the home. That is not to say the creditor cannot let his judgment sit as a lien and “season” over time, waiting for the owner’s equity to increase.  

If the equity is more than $125,000, the creditor can take the home, but the owner first gets $125,000 to keep (after the mortgages are paid) and may put that into another home.  

Individual retirement accounts, 401ks, and life insurance policies are also exempt from creditors. This is a great reason to maximize retirement contributions. Not only do retirement accounts offer tax savings, but they are protected from creditors.

Social Security income is another exempt asset.   

It is a popular myth that putting assets into a trust will keep them out of reach from creditors. This is only half true.  

First, for the uninitiated, a “trust” is a relationship where one person, a trustor, gives an asset to another, the trustee, with the expectation that the trustee will follow the trustor’s directions in managing the asset to benefit another, the beneficiary. In legal jargon, the “legal” title (held by the trustee) and the “equitable” title (held by the beneficiary) are split.   

A self-settled trust, where the trustor is his own beneficiary, is fair game for creditors. In these situations courts look at form over substance, and allow creditors to invade trust assets to pay the debts of the trustor/beneficiary.

On the other hand, non-self-settled trusts are typically exempt from creditors. A non-self-settled trust is created when someone irrevocably puts assets in trust for the benefit of another. Estate planners typically advise clients to use this type of trust in order to give children-heirs the benefit of an inheritance, while not giving them legal title. This type of trust will stymy creditors.   

Another popular myth is that gifting assets to a friend or family member will automatically keep them from creditors. If the gift is so large that it leaves the donor with nothing but debt, it is called a “fraudulent transfer.” Creditors can (and often do) undo these transactions.

There is no magic bullet to living risk-free. Being careful, honest and fair in business is the best way to protect against lawsuits. Carrying insurance is a must too. Maximizing one’s creditor exemptions can be another good idea.