How to Protect Assets through Life Insurance & Annuities

Life insurance and annuities may be used for asset protection as well as estate planning. Both federal and state laws include some exemptions for the cash value or the proceeds of life insurance. As with other exemptions (like wages, homestead), the amount protected from creditors varies from state to state. With annuities, not every state protects them from creditors, and the ones that do vary in terms of the amount protected and under what circumstances.

Life Insurance

There are two basic types of life insurance, term life insurance, in which you pay only for a death benefit, and whole life insurance, in which you pay additional money, which builds up as savings. Exemptions in most states protect at least some of the value of your policy from creditors’ claims. Upon your death, in most states, the proceeds can pass to your beneficiaries free of any claims of your creditors. In some states, property that is purchased with the proceeds of a life insurance policy is also exempt.

There are exceptions to the protections, however. In a few states, a life insurance policy is exempt from creditors’ claims only if the beneficiaries are the spouse, children or other dependent(s). In some states, if the owner of the policy has the power to change the beneficiary, the proceeds are not protected. Additionally, even if a policy is originally exempt, the protection can be lost by:

• Assigning your policy to a creditor. Note that often loan papers prepared by banks contain clauses that can give the bank a right to your life insurance policy. Read the fine print!
• Buying a policy and paying the premium for it when you are insolvent. This would constitute a fraudulent conveyance and, if challenged, be found nonexempt.
• Changing the beneficiary while you are insolvent.

If another person owns your insurance policy, your creditors cannot reach it because it is not your property. If you make a gift of your policy to your spouse or children, the gift must be absolute. You may not retain any control over the policy or you will lose the asset protection benefit.

Extra asset protection may be provided if you place your insurance policy in an irrevocable life insurance trust. With this type of trust, you transfer either an existing policy or the funds to buy one.

Annuities

Annuities offer another option for protection from creditors’ claims in some states. An annuity is an agreement whereby a person is to get a sum of money regularly over a period of years. There are fixed annuities where the amounts are determined in the beginning, and variable annuities where the amount to be paid out depends upon the return on investment. To set one up, you can pay a lump sum, or you can make periodic payments. They are useful in asset protection planning because they are exempt from claims in several states. The exemption ranges from a few hundred dollars in some states, to an unlimited amount in others. In some states, all annuities are exempt, while in others only annuities payable to one’s spouse, children or other dependents are exempt.

In some states, such as Florida, annuities have especially strong protection. In one case, a woman who was injured in an auto accident had her million-dollar settlement structured as an annuity. Years later, she caused an accident and injured someone else. Her victim was unable to get anything from herbeyond her liability insurance policy.

Annuities are currently enjoying great popularity and are offered by many of the large mutual fund companies such as Fidelity, Vanguard, Dreyfus and Scudder. There are dozens of varieties to choose from. Besides asset protection, another benefit available with annuities is the tax-free compounding of the investment, since the interest is not taxable until it is paid out. It is like an IRA but with no limit on the amount you can contribute.

If you live in a state that does not allow an exemption for annuities, there are annuities available outside the United States, such as in Switzerland. Swiss law provides that if your beneficiary is your spouse or children, or made irrevocable, the annuity cannot be reached by creditors.

Case Studies: Protecting Assets Through Life Insurance & Annuities

Case Study 1: Life Insurance Exemptions Vary by State

John, a resident of California, had a life insurance policy with a substantial cash value. California law protects the cash value of life insurance policies from creditors’ claims, allowing the proceeds to pass to John’s beneficiaries free of any claims.

However, John later changed the beneficiary to his business partner, which resulted in the loss of the asset protection benefit. This highlights the importance of understanding the specific exemptions and limitations of life insurance in each state.

Case Study 2: Irrevocable Life Insurance Trust for Enhanced Protection

Sarah, a resident of Texas, sought additional asset protection for her life insurance policy. She decided to establish an irrevocable life insurance trust (ILIT). By transferring her policy to the ILIT, Sarah gained extra protection for her insurance policy. The trust ensured that the policy’s cash value and proceeds were shielded from creditors’ claims, providing greater peace of mind for Sarah and her beneficiaries.

Case Study 3: Annuities as Powerful Tools for Asset Protection

Mark, a resident of Florida, utilized annuities to safeguard his assets. Florida law provides strong protection for annuities, making them an effective tool for asset protection.

Mark structured his settlement from an auto accident as an annuity, and years later, when he caused another accident, his victim couldn’t access the annuity funds beyond Mark’s liability insurance policy. This is demonstrates a significant asset protection potential offered by annuities in states with favorable laws.