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Disclosures: References: Wealth Planning for the Modern Physician and Wealth Management Made Simple are available free in print or ebook formats by texting HEALIO to 47177 or at www.ojmbookstore.com. Enter code HEALIO at checkout. For more information: Sanjeev Bhatia, MD, is an orthopedic sports medicine surgeon at Northwestern Medicine in Warrenville, Ill. He can be reached at sanjeevbhatia1@gmail.com. David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm, OJM Group, www.ojmgroup.com. You should seek professional tax and legal advice before implementing any strategy discussed herein. He can be reached at mandell@ojmgroup.com or (877) 656-4362.Bhatia and Mandell report no relevant financial disclosures.

January 14, 2021
4 min read
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Use exemptions to protect assets from future liability

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Disclosures: References: Wealth Planning for the Modern Physician and Wealth Management Made Simple are available free in print or ebook formats by texting HEALIO to 47177 or at www.ojmbookstore.com. Enter code HEALIO at checkout. For more information: Sanjeev Bhatia, MD, is an orthopedic sports medicine surgeon at Northwestern Medicine in Warrenville, Ill. He can be reached at sanjeevbhatia1@gmail.com. David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm, OJM Group, www.ojmgroup.com. You should seek professional tax and legal advice before implementing any strategy discussed herein. He can be reached at mandell@ojmgroup.com or (877) 656-4362.Bhatia and Mandell report no relevant financial disclosures.

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In past articles, we introduced the concept of asset protection planning — implementing techniques to shield a physician’s personal and practice assets from potential future lawsuits and liability.

The unfortunate reality is that we live in an era of increased litigation, so this discipline should be a part of every doctor’s overall wealth planning.

In future articles, we will discuss a variety of tools that can be used to protect assets in various degrees. In this column, we revisit the important background of such planning — the asset protection sliding scale — and the best type of protection one can achieve through federal and state exempt assets.

For more than 20 years, David has used the asset protection sliding scale to designate assets in a range from -5 (totally vulnerable/no protection) to +5 (highest level of protection). Exempt assets protect the +5 top level.

Sanjeev Bhatia, MD
Sanjeev Bhatia
David B. Mandell, JD, MBA
David B. Mandell

It should be noted that the goal of asset protection planning is not to move all of a doctor’s assets to a +5 position. This simply is not possible, even in states that have the most protective laws. On the other hand, many physicians have many of their personal or practice assets in negative positions, with little or no shield. At a minimum, nearly all doctors would do well to move the bulk of their personal and practice assets to positive positions.

Exempt assets: Best protection tools

We consider exempt assets to be the best asset protection tools for the following reasons:

No legal/accounting fees. Most of the tools that we will discuss in future articles involve the creation of legal entities that require setup and ongoing legal fees, state fees, accounting fees and even additional taxes. Using exempt assets involves none of these significant costs and affords better protection as well.

No loss of ownership or control. Legal tools typically require giving up some level of ownership or control to family members or even third-party trustees. By using exempt assets, you can own and access the asset at any time while enjoying the highest +5 level of protection.

Superior protection. The legal tools explained below offer protection that ranges from +1 to +5. Exempt assets always enjoy the top +5 protection up to their exempt amount.

Federally exempt assets

Federally exempt assets are assets that are protected under federal bankruptcy law, which protects certain assets from creditors and lawsuits if the defendant is willing to file bankruptcy to eliminate the creditor. In a Chapter 7 bankruptcy, the debtor is able to keep any assets that federal law deems exempt.

The two significant asset classes that federal law protects are qualified retirement plans (QRPs) and individual retirement accounts (IRAs). A QRP is a plan that complies with certain Department of Labor and IRS rules. For the protection to apply, the plan should also comply with the Employee Retirement Income Security Act. Most plans with non-owner employees will, but be sure to check your plan.

One might know QRPs by their specific type, including profit-sharing plans, money purchase plans, 401(k)s, and 403(b)s. Although there are several technical differences, IRAs are similar to these plans and are also given exempt status under federal law.

While the protection for QRPs and IRAs is +5, this protection applies only if one is in bankruptcy and has access to the federal exemptions. The amount of value in the QRP or IRA that would be protected outside of bankruptcy, as with an ordinary lawsuit and creditor action, is governed by one’s state law. Fortunately, every state provides its own exemptions as well.

State exempt assets

Leveraging state exemption is a fundamental part of wealth planning and one that every physician should take seriously. The most significant state exemptions are QRPs and IRAs; primary residence (or homestead); and life insurance and annuities. Important note: We make general comments regarding state exemptions, but these are not meant to be accurate for any particular state.

QRPs and IRAs. Nearly all states have significant +5 exemptions for QRPs and IRAs. Some states protect only a certain amount or protect QRPs more significantly than they do IRAs. It is crucial that a physician understand the exemptions for retirement plan assets in his or her state and build wealth accordingly.

Primary residence: Homestead. Most states protect only between $10,000 and $60,000 of the homestead’s equity. Some states, such as New Jersey, provide no protection, while other states, such as Florida and Texas, generally provide unlimited protection (with some restrictions). Given today’s real estate values and the equity that many doctors have in their homes, it is clear that most states’ homestead exemptions provide inadequate protection.

Homestead protection is often automatic, but it may require additional action in some cases. Each state has specific requirements for claiming homestead status. In some states, one must file a declaration of homestead in a public office. Other states set a time requirement for residency before homestead protection is granted. One should never assume that the home is protected, but rather confirm with an advisor familiar with local requirements.

Life insurance and annuities. All 50 states have laws that protect varying amounts of life insurance and/or annuities. One should check with an experienced advisor on the rules in a particular state. Some general observations are as follows:

  • Some states protect life insurance policies only, but not annuities or vice versa;
  • Some shield both cash values and death benefit proceeds for both life insurance and annuities, some for one policy/annuity element but not the other;
  • Many states shield the entire policy/annuity from the owner’s creditors. Some also protect against the beneficiary’s creditors;
  • Many states protect the policy proceeds only if the policy beneficiaries are the policyholder’s spouse, children or other dependents; and
  • Some states protect a policy’s cash surrender value in addition to the policy proceeds. This can be the most valuable exemption opportunity.

Tools used to achieve the highest level of asset protection are +5 exempt assets. It makes sense that physicians who are interested in asset protection should attempt to maximize their use of exempt assets.

For more information:

Sanjeev Bhatia, MD, is an orthopedic sports medicine surgeon at Northwestern Medicine in Warrenville, Ill. He can be reached at sanjeevbhatia1@gmail.com.

David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm, OJM Group, www.ojmgroup.com. You should seek professional tax and legal advice before implementing any strategy discussed herein. He can be reached at mandell@ojmgroup.com or (877) 656-4362.

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