Trusts and LLCs Still Leave Personal Assets at Risk
APRIL 5, 2022
Families implement trusts and limited liability companies (LLCs) as part of an asset protection strategy.
Placing the ownership of homes, automobiles, boats and other assets into trusts and LLCs provides tax, privacy and wealth protection. Creating trusts and LLCs places a layer of protection between the asset and personal assets. In the event of a loss, personal assets are protected if the entity is sued.
Entity Assets Need Protection
Although a layer of protection is initially produced by the creation of an entity, proper guidance is necessary to keep that layer of protection in place. Issues arise when assets are placed into an entity and families are not given next steps.
The easiest way to protect an entity is to consider it a person. Let’s consider the following hypothetical: We created an entity called Burt. Burt has a home in his name. He does not place insurance on it. If the home burns down, Burt must pay out of pocket to replace it.
The same is true for any asset that is in the name of a trust or LLC. If no insurance is in place, the asset is left underinsured or uninsured. Various insurance policies are available depending on the asset at risk and the intent behind the LLC or trust.
Insured, Additional Insured, Additional Interest: What’s the Difference?
Listing a trust or LLC as the named insured (i.e., the policyholder) impacts coverage. Let’s use our previous example: Burt owns a home and is the named insured on the homeowners policy. Burt now has dwelling and liability coverage. The family residing in Burt’s home will need a renters policy to cover their contents and provide liability.
In comparison, if Burt is listed as an additional insured or additional interest on a homeowners policy, the family living in the home would be named insureds. There is no need for a separate renter’s policy. The dwelling, contents and liability insurance is in the name of the family. This may seem like a great alternative; however, the additional layer of protection created by the entity is gone.
Ramifications of Co-mingling Assets
State law treats both trusts and LLCs as legal entities. It is therefore imperative that a family’s finances and the entity’s finances remain separate.
“Insurance premium payments are one of the areas where clients often think it’s harmless to pay the premium directly even if there is a trust or entity involved. If there is a lease agreement in place for use of the home or vehicle, direct payments may be proper. Otherwise, paying directly, instead of having the entity-owner make the payments, could create a bad fact to help someone punch through the protections of the LLC,” notes estate planning partner Lauren Wolven of Levenfeld Pearlstein, LLC, in Chicago.
There can be no co-mingling of funds. Once funds are co-mingled, the additional layer of protection is gone. The family’s personal assets are at risk in the event of a lawsuit.
A lawsuit can be filed against a trustee for almost anything, even if no mistakes were made. Lawsuits bring legal fees, reputation damage and additional stress. Fortunately, trustees of trusts have insurance options available to protect their personal assets.
Trustee error and omission (E&O) policies assist in protecting a trustee from a lawsuit related to their professional handling and management of a trust. Without this policy, a trustee may have to pay out-of-pocket legal costs (and potentially damages) in the event of a lawsuit. The policy applies to suits alleging:
- Co-mingling of trust money
- Mismanagement of trust assets or poor investment decisions
- Beneficiaries believing they did not receive their fair share of the assets
- Conflict of interest if the trustee is also a beneficiary
- Negligent selection of outside professionals hired by the trustee to assist in administering the trust
- Negligence for not hiring outside professionals to administer the trust
- Negligence for not following terms in the trust
Homes placed in an entity may employ domestic staff to maintain the residence. If an entity employs domestic staff, consider employment practice liability insurance (EPLI). This insurance provides families and entities coverage from lawsuits filed by employees. EPLI protects against:
- Discrimination (on the basis of sex, race, age or disability, for example)
- Wrongful termination
- Other employment-related issues, such as failure to promote
Another area to consider if staff is employed is workers’ compensation. Workers’ compensation insurance provides benefits to entity employees who are injured or become ill on their jobs. Further, workers’ compensation insurance is required by most states if you have employees. Check your state law to confirm compliance.
Entities created for a commercial enterprise (income generation) need commercial coverage. Not all insurers are equally equipped to deal with such an exposure. Having a broker assist in finding insurers capable of providing sufficient coverage is crucial.