A recent article in Financial Planning reminded me of the remarkable role captive insurance companies can play in asset protection and generational wealth transfer. To read the entire article in Financial Planning, CLICK HERE. The Supreme Court recently passed down a ruling that “signals change for any client planning to pass along an IRA to heirs – and perhaps for some who have inherited IRAs themselves,” according to Financial Times contributing author Ed Slott. In June, the Supreme Court ruled unanimously that inherited IRAs are not protected in bankruptcy. Writing primarily to financial advisors and CPAs, Slott notes that “Your clients should know that the IRAs they built could be lost if their children have financial problems.” In the case Clark et ux. v. Rameker, Trustee the court ruled that inherited IRAs are no longer retirement accounts, and could, therefore, be seized by creditors.
The Supreme Court decided that inherited IRAs do not contain “retirement funds” as defined by federal bankruptcy law — and, as a result, are not protected from creditors. Put another way, at the moment an IRA owner dies and the IRA funds pass to a beneficiary, their character changes from that of retirement funds to nonretirement funds.
Slott noted that the ruling left spousal rights up in the air. If a spouse inherits an IRA, can it be seized by a creditor as well? Financial Times noted that, “Since the court’s decision was handed down, experts have been questioning just how wide a net the Heffron-Clark decision casts…[d]oes it affect spouses who inherit an IRA?”
Slott makes the salient point that, “The question now is how to keep clients’ hard-earned money safe if their heirs run into trouble with creditors.”
What Role Can A Captive Insurance Company Play In Asset Protection And Estate Planning?
So, what is the connection between captive insurance companies, estate planning, asset protection, and inherited IRAs being vulnerable to creditors? Simply put, in addition to serving as a powerful risk management vehicle, a captive insurance company can also protect assets and facilitate both the transfer and protection of wealth to future generations.
What Is The Primary Purpose Of A Captive Insurance Company?
Before we discuss this ancillary benefit of owning a captive insurance company, it must be noted that the primary reason to form a captive is to improve risk management. A captive insurance company is a licensed insurance company that insures one or more related businesses. Captives have the unique ability to write customizable insurance coverage for business entities. They can also fill gaps in third party, commercial insurance policies. As such, they can form the backbone of a company’s Enterprise Risk Management (ERM) strategy. Owning a captive insurance company can enable a business owner to amass significant loss reserves to protect the business in the future.
Insurance company profits are retained by the owners of the captive. In the case of small to mid-size businesses, the captive can often be owned by the business owner (s), heirs or a trust for the benefit of the heirs. Because a captive is a licensed insurance company, it receives favorable tax treatment which facilitates the accumulation of wealth.
Why Is A Captive Insurance Company A Powerful Asset Protection Vehicle?
A properly structured captive insurance company is one of the most formidable asset protection vehicles available to businesses and business owners. When a business owner chooses to formally insure risks by owning a captive insurance company, the business owner benefits from insurance law and taxation. By law, insurance company reserves are obligated (or protected) to pay potential claims for the insurance policies they back. The captive insurance company and its assets have a specific purpose – to back policies. As such, it is virtually impossible for a creditor of the business owner, parent company or future heirs to lay a valid claim against the assets of a properly structured captive insurance company.
How Can A Captive Both Facilitate Transfer Of Wealth To Future Generations And Protect Wealth For Future Generations?
For the reasons listed above a properly structured captive insurance company can protect wealth for future generations even in the event of future bankruptcy. Also, a captive insurance company can be owned by one’s heirs or a trust for the benefit of one’s heirs. In this way, a business owner or owners can set-up their heirs as a supplier or service provider to their business. The captive insurance company provides insurance to the parent company and related companies in exchange for premiums paid by the business or businesses to the captive. The captive will pay claims when the parent company or companies experience an insured loss, however, a well-run captive insurance company will be profitable and amass significant wealth over the long term. The result is both a tax efficient and asset protected transfer of wealth to future heirs.