Steps Business Owners, People in Risky Professions and the Average Joe Can Take to Keep Their Assets Safe
In my last article, I (hopefully) explained how incorporating may not provide the liability protection people expect. In this one, I will explore some of the steps we can take to keep family assets safe, most of which don’t involve forming a company.
(a) Planning Ahead
The key factor in any of the steps mentioned in this article is when you take action; if you only start planning to secure your assets after the wolves are already sniffing at your door, then it is likely too late. Our legal system has some scary sounding terms like “fraudulent conveyance” and “fraudulent preference.” These terms apply to transactions like gifting or transferring assets to a family member for less than market value or paying out certain creditors and stiffing others. If a court determines that you have taken steps to thwart those aforementioned creditors after you are already insolvent or have creditors coming after you, then it can set aside the transactions.
As well, the Bankruptcy and Insolvency Act also has provisions that allow the trustee in bankruptcy (the person appointed to control and distribute your assets) to go after transactions like RRSP contributions made within the year prior to bankruptcy. The courts may also potentially set aside earlier transactions if your creditors can prove that you were already in dire financial straits at the time you made them as well. Although I won’t belabour this point below, please remember that any of the steps mentioned might not work if you take them too late!
(b) Not Mixing Assets and Liabilities
I was speaking with Peter Temple of 4 Pillars, a company that helps people get out of debt and rebuild their credit ratings (https://www.4pillars.ca/bc/burnaby) last week and he told me that he suggests his clients keep assets like non-registered investment and bank accounts at a different institutions than those that hold their mortgages, business loans and other types of debt. If you keep your assets at the same place as your debts, the banks are able to simply swoop in and collect their pound of flesh from your assets if you fall behind on you debt payments through their right of offset. Although the financial institution can still go after your investments at other banks or credit unions, at least it won’t be as simple as merely having someone in press a button and draining your accounts.
Of course, financial institutions know the rules of the game as well and often ‘encourage’ customers to do all their banking at a single institution. Moreover, you might also get better rates or lower fees if you show a little loyalty. Ultimately, the choice is yours but I don’t think that it is a bad idea to at least have a few emergency dollars squirrelled away somewhere else.
(c) Registering your Home in Your Spouse’s Name
Many business owners and professionals such as doctors and lawyers who are worried about lawsuits in the future have their homes and similar assets registered solely in the names of spouses. If ever sued, the home is usually only up for grabs if the spouse on title is also liable for the debt. For example, if a business is solely in the name of one spouse, who is later sued as a result of a dispute with a supplier, the house will be off limits if it was registered solely in her husband’s name before the problems started.
Unfortunately, as mentioned in my last article, financial institutions generally want both spouses to secure business debts and to pledge the family home as collateral for business debts, even to corporations. As a result, this type of planning won’t work in every situation.
Moreover, if you have a mortgage on your home, you may not qualify for the mortgage in the first place without using the higher income spouse’s earnings. On a similar note, if you are already both on title and have a mortgage, banks are reluctant to let the at-risk spouse off the hook. If you are in either of those situations, try having the spouse at risk guaranteeing the mortgage rather going on as a borrower. This will still allow the bank to both foreclose on the house and go after both spouses’ other assets. On the other hand, the at-risk spouse’s other creditors won’t be able to attack the house. Although the family may have to sell the house in the end eventually if they are not able to keep up payments, this should at least maximize the amount of equity they get to keep when that unhappy day finally comes.
What happens if the house is owned in both names and only one spouse has creditor issues? In most cases, the family is usually able to continue living in the house since the non-debtor spouse is on title. The creditors generally get and register a judgment from the court confirming the debt against title. From that point on, it is generally a waiting game. When the family wants to sell the place, the buyers will insist on the registered judgement getting paid from the sales proceeds so that they don’t become responsible for the debt. On the other hand, if the debtor spouse dies first, the surviving spouse is able to avoid the debt as the debtor’s interest in the property dies with him or her.
There are other factors to consider when deciding how to set up title on your home, so I do suggest getting good legal advice before taking any further steps. For example, putting title in one spouse’s name solely can mean triggering unnecessary probate fees if that spouse dies first. It can also cause problems in a blended family situation if the at-risk spouse is worried about his spouse not providing for his children from a previous marriage or other heirs if he is the first to die.
(d) RRSPs, RRIFs and Pensions
It seems that a lot of people are anti-RRSPs these days, in part because of the potential tax problems that come later when pulling money out during retirement. While I could argue that this is usually a better problem to have than running of money in your 80’s, I will instead focus on creditor protection. Both federal bankruptcy law and British Columbia’s creditor enforcement laws protect RRSPs from creditors, except for contributions made after problems have already started or a year prior to bankruptcy.
As an extra benefit, RRSPs and RRIFs are also exempt from estate creditors on the debtor’s death if the debtor designates a beneficiary other than his estate. Unfortunately, this creditor protection only lasts while the money is inside the RRSP; if the debtor needs to make withdrawals, the money taken out is up for grabs if the creditors can find it. Moreover, if a beneficiary has their own creditor issues, the money will also be up for grabs once it is no longer sheltered inside an RRSP. A surviving spouse who is also liable for the debts should be okay if she is a successor annuitant (i.e. the RRSPs are rolled over to them) but only while the money stays inside the plan.
As a result, clients in risky professions or owning their own businesses may wish to maximize RRSP contributions. Not only will they get creditor protection and immediate tax relief; they also don’t have all their retirement hopes pinned to the success of their business. Likewise, they might also decide to make spousal RRSP contributions so that can also avoid any creditors still sniffing around during retirement; if their spouse isn’t also liable for the debts, the money should also be safe in the withdrawal phase since it is considered the spouse’s income for tax purposes if it has been left in the RRSP long enough. As a final bonus, the income splitting rules for RRSPs still allow up to 50% of the income to be taxed in the at-risk spouse’s name, which can reduce the tax bill that would otherwise result from having all the family’s RRSPs registered in just one spouse’s name once that spouse turns 65 and converts the RRSP to a RRIF.
(e) Life Insurance and Life Insurance-related Investment Products
Personally owned life insurance policies and investment products such as accumulation annuities (which are like GICs) and segregated funds (which are the life insurance industry’s alternative to mutual funds) provide a feature that many people don’t realize: creditor protection. If the policy or insurance asset’s beneficiaries are qualifying family members, such as children, grandchildren, spouses and parents, the insurance product is usually exempt from seizure during the owner’s lifetime. Even better, if a qualifying beneficiary is named, the money is also exempt from any claims creditors could make against the estate.
On a related note, if you have named an irrevocable beneficiary (i.e. you can’t change beneficiaries without that person’s permission), that beneficiary’s portion of the policy is also creditor-protected. In practical terms, if you owe money to a business partner or friend or wish to ensure that certain debts get paid off on your death, this step may go a long way to making sure this happens.
In practical terms, term insurance policies wouldn’t really interest creditors that much anyway (unless it appears the debtor is in poor health), since there is no immediate cash value to them. On the other hand, some permanent insurance policies and the other insurance products I just mentioned have a significant cash value. Unfortunately, the timing of premium payments or contributions affects whether these payments are vulnerable to creditors, as I warned earlier.
It is also worth knowing that some insurance products allow the owner to convert the products into an annuity (which used to be really common for permanent life insurance policies before the law changed to reduce the tax incentives for doing so for newer policies.) Of course, each individual payment made by the annuity to the owner can be seized if the debtor is organized and motivated enough to take steps, which probably isn’t too likely.
Finally, if you already have creditor issues, be sure to get expert advice before changing policy beneficiaries, as this might void the creditor protection; the timing of taking out, paying into and naming beneficiaries on the policy or other insurance products plays a huge part in determining how much creditor protection they ultimately enjoy.
(f) Individual Pension Plans
Jealous of workers with big government pensions for life and own your own incorporated business? Create your own “Individual Pension Plan” or “IPP.”
Now is not the time to discuss the finer points of IPPs, but I do think a thumbnail sketch is in order. Simply put, your company can fund and write off contributions to a private pension plan administered by an outside party that is creditor-protected. This is usually done with the help of an actuarial firm, as an actuary has to calculate and periodically review how much money is required to pay for the benefits promised under the pension and to see if money set aside and subsequent investment returns are on track to deliver on this promise.
The money in the plan is invested and, at retirement, it can be converted to a pension by purchasing a life annuity. It can also be transferred to a Life Income Fund (“LIF”), which allows you more flexibility when choosing when and how much to withdraw, while also ensuring that the remaining balance at your death passes to your named beneficiaries. In many ways, it is like RRIF account (what RRSPs are converted to in most cases). There is a minimum amount that must be withdrawn each year from the LIF, which is calculated just like the minimum amount for a RRIF. On the other hand, unlike RRIFs, there is also a maximum amount that can be withdrawn as well in most Canadian jurisdictions. As a result, while a LIF is more flexible than an annuity or pension, it isn’t quite as flexible as a RRIF.
The amount of money that can be contributed to an IPP each year is calculated differently than for RRSPs. Rather than a set percentage of your wage up to a set limit, the contribution limit is based on life expectancy assumptions for people of your age and gender, assumed growth rates for any contributions and what benefits and features (such as indexing, survivor guarantees) the selected pension provides. Moreover, if the investment returns on previous contributions haven’t done as well as estimated, the company can contribute additional funds to put the pension back on track. In some cases, the pension can also fund years of employment at the company before the pension started, although the worker may be required to contribute some of their own RRSP money to the pension to help fund these past service benefits. In some cases, contributions in the year of set up can easily exceed $100,000, all of which deductible by the company and none of which is taxed in the employee’s hands until withdrawal, at which time each payment is taxed like essentially like an RRSP withdrawal.
Owners generally only set IPPs up for themselves and other employee-family members, as they are usually reluctant for their companies to take on the obligation of making up any investment shortfalls for non-family members in most cases. In provinces like B.C., however, the company does not have to make up these contributions for specified persons, such shareholder owners and high net worth employees. From a practical perspective, this makes setting up an IPP less risky to the company’s future economic health.
There are initial set up costs, as well ongoing actuarial and administration costs that go along with IPPs but some actuarial firms are willing to lock in their costs so that you have a far better idea of what you’re getting into when you sign on the bottom line.
In summary, IPPs allow your company to set aside large amounts of money into creditor protected accounts that also provide tax benefits to your company. Once more, the timing of contributions is key when looking at creditor protection. Also, be sure to get expert advice to see if an IPP makes sense for you. They are particularly useful for shareholder / employees with stable, significant incomes in their 40’s and older.
(g) Setting Up Trusts or Gifting Assets Before Trouble Is Brewing
As this article is already long enough, I won’t say too much on this subject. Although transactions made to avoid creditors when things are already rocky can be set aside as “fraudulent conveyances,” this doesn’t apply to transfers before that point.
Putting your assets into a trust or using a trust to own shares in a family company may also protect those assets from creditors as well, in addition to potential tax benefits. In some situations, especially if you are not a beneficiary of the trust and can’t name yourself as a beneficiary at a later date, you can even still control the assets, who gets money from them and who ultimately gets to keep them. In many cases, however, putting assets into a trust will unfortunately trigger an immediate tax bill. Accordingly, be sure to get tax and legal advice before proceeding.
You might also have relatives who might leave you money at a later date arrange to leave them to you in trust as well, provided that other people are potential beneficiaries as well and there is discretion as to who gets what and when. You would likely get even more creditor protection if you are not the trustee of this trust or you are able to appoint someone else, such as a sibling, as trustee when you have creditor concerns. Ultimately, using trusts might allow you to keep an inheritance or at least ensure that another family member gets it instead of your creditors.
(h) Get Adequate Liability Protection
If you are in a profession that is at risk for hefty law suits, make sure that you have lots of liability protection so that it is the insurance company that ultimately pays the costs of any law suit, not you. Likewise, make sure that you have significant liability coverage under your homeowner’s insurance or similar policies and under your automobile insurance as well. The costs of buying extra liability insurance decreases dramatically the more you get, as the insurance companies know that they are extremely unlikely to have such a significant claim. Accordingly, this is factored into what they charge you for this protection.
On a similar note, make sure that you have business insurance if you are running a home-based business that involves the clients coming to you. Your general house insurance will probably not cover you if a client slips and falls or otherwise gets injured at your home, so be sure to discuss this issue with your general insurance agent and to purchase additional coverage or a rider to your existing policy.
(i) Lending Instead of Gifting
If you feel pretty good about your own creditor situation but are worried about that of your kids, lend but don’t gift. Although you may still want to help them financially, such as making sure that they have the down payment for a new home or car, structure this assistance as a documented loan rather than a gift. That way, if your kids’ creditors ever come calling, there is a good chance that you will be able to get some or all of the money back. You do not have to charge interest or set payment terms on the loan (unless you want to) and can always forgive the loan later or in your Will.
Want extra protection? Consider registering the loan with the Land Title Office if it is used to fund a home or with the Personal Property Registry if used to buy a car or similar asset. In that case, your debt will have priority over subsequent creditors unless your kid has already signed a security agreement that covers subsequently acquired property. In that case, you may wish to have the asset registered in your name and simply let your child use it (although be careful about guaranteeing debts.) Alternatively, in the case of a house, you could be on title as a partial owner. For example, if you fund 10% of the purchase, you might want to go on title as owning 10% of the property as a tenant in common, which means that this portion is exempt from your child’s creditors.
There may be some negative tax consequences to going on title as a partial owner of your children’s homes, so do get professional advice before doing so; ultimately, you would probably want to take this step only if the negative tax consequences weren’t as bad as the potential creditor risk.
(j) Be Careful When Putting Your Children On As Joint Owners and Document Your Intentions
Although many people add their children as joint owners of their homes and other assets for estate planning purposes, this can also potentially cause creditor problems. While I do think that joint ownership of assets with the next generation can be an extremely useful strategy, it is not right in all situations and must be done correctly.
Without going into the potential tax and estate planning problems that can go with not documenting the purpose of putting your kids on title, this lapse can also mean creditor problems. It is possible to avoid many of these problems by having a lawyer have your kids sign a document confirming that they are only on title for estate planning purposes and that the assets are really yours during your life time. This means that your assets will be safe if from your kids run into creditor problems or get divorced.
It can also be used to protect you against your children themselves! To take this extra step, you could even get your kids to execute an irrevocable power of attorney regarding the asset that allows you to take them off title without notice or even have them sign an undated land transfer document.
(k) Incorporate / Create a More Creditor-Proof Corporate Structure
A company is recognized as a separate legal person for liability purposes in many situations. Although it is not universal or bullet-proof protection (see my last article), it can still be a heck of a good thing. If suppliers and customers know they are dealing with a company, you will likely not be personally liable for claims against the company, absent fraud or personal guarantees for the debts. As your company grows, you can increase your protection by getting lenders to release you from personal guarantees. As well, you can own some of your company shares inside a trust or have other family members own shares so that these assets are protected from suits against you personally.
If you are already incorporated, you may want to tweak your corporate structure to drain your company of assets and transfer them to holding companies that are hopefully immune from suits against the company. There are many ways of doing this. One common option is to have a holding company (potentially with a trust involved as well) that owns shares in your operating company (your active business.) The business can pay dividends to the holding company without triggering tax if set up correctly. Accordingly, if the active business is sued, you will have already transferred out all of the excess cash, which hopefully means you can tell your creditors to pound sand.
If it makes sense for your active business to continue owning assets, perhaps in anticipation of tax relief at a future sale, other steps may make sense. A common strategy involves your active business dividending excess earnings to a holding company, then turning around and borrowing it back from your holdco to buy business equipment. Your holding company then registers the loan with the government, which gives it preferred status as a creditor if your operating company is ever sued. As a result, your creditors will likely only be able to collect whatever is left after the loan to the holding company is paid out.
Finally, many businesses keep the business premises in a separate company from the active business, in part for liability purposes; if the active business is sued, the real estate is hopefully protected from any judgment creditors. As you can see, creditor protection not only applies to your personal assets but to how your corporate assets are owned as well!
In many ways, creditor protection is like insurance; by the time you need it, it is likely too late if it is not already in place. As well, although it is not ultimately necessary in most situation, the consequences of not having it in place can be dire when things go wrong. Finally, although there may be costs (or at least additional hassle) of getting creditor protection, they should be a lot less than the potential consequences of doing without (otherwise, why bother?)
I suggest sitting down with the appropriate professional advisor to get a better handle on your own situation and the steps that make sense for you. Already in a pickle? Consider talking to someone like Peter Temple, who can hopefully negotiate a settlement with your creditors for as little as possible, then help you rebuild your credit afterwards.