Best ways to protect your wealth

How important is wealth protection?

The answer, of course, is extremely important. Many people have come into significant wealth, even generational wealth, only to squander it all in just a few years. This phenomenon happens all too often.

Just take a look at this list of lottery winners who ended up broke. Or this list of professional athletes who ended up broke. Or this list of musicians who ended up broke. You can find even more examples with a casual search.

Usually, these people had far more wealth than the average worker can realistically obtain in a career (although don’t underestimate the power of compound returns over decades!). And the reasons for their financial downfalls are varied. Some had spending problems; some had drug or alcohol problems, some fell prey to “friends”, family, lawsuits, scams, theft, or other crimes. One thing is for certain though: all of them failed to protect their wealth, yet none of them went bankrupt because of a stock market crash. Think about that for a minute. Wealthy people do not go bankrupt from stock market crashes. So when I talk about wealth protection, I am NOT talking about avoiding market volatility!

Instead, I am talking about the physical, legal, and psychosocial factors that go into wealth protection and preservation. It really doesn’t matter how much wealth you have - if you can’t protect it, you won’t end up with any!

What are some common sense practices to protect and preserve your wealth?

Do not show off or flaunt your wealth

This is, in my opinion, the single most important thing you can do, because it’s not one particular action, but an overall mindset that permeates all of your activities and decisions.

One of the best ways to do this is to simply be frugal and live within or below your means. This has multiple benefits. The first, obviously, is that you’re not likely to squander your wealth from excessive spending. You can save and invest more, and achieve financial independence sooner (take a look at my time to retirement calculator). Another hidden benefit, however, is that you don’t project an image of wealth. This makes you a less obvious target to thieves, scammers, lawsuits, jealous friends and co-workers, or even financially manipulative members of your own family. One downside of wealth is that wealth attracts attention, whether wanted or not, as many professional athletes, celebrities, and lottery winners experience first-hand. It’s best to fly under the radar.

But A Frugal Doctor! If I don’t show off my wealth, my friends, family, and neighbors will think that I am poor or unsuccessful, and I won’t receive the validation that I need! I doubt anyone says this out loud, but we all live it to some degree. To this I say: let them think what they want. Here’s Warren Buffet, driving himself to work in the morning in a nice, but not exotic, Cadillac, and buying fast food from McDonald’s:

Buffet has a net worth of over $100 billion, but is famously frugal. Many other billionaires drive similarly plain vehicles. Of course, some of them probably have exotic car collections. But very few truly wealthy people flaunt their wealth publicly or on social media.

Also, it would be nice if your ego was impervious to what other people think. This is much easier said than done, of course, but on a personal level, I found that it does get easier with age as well as an increasing sense of financial security.

And if you’re ever been inclined to talk to friends, co-workers, or even family about your wealth, perhaps this, or this, or this, or this post (among dozens, if not hundreds more) from the r/financialindependence subreddit will persuade you otherwise.

Have adequate liability insurance

I mentioned above that one downside of having wealth is that it can attract unwanted attention. Another downside is that the more you have, the more you have to lose. And this disproportionally affects people who have a reasonable retirement nest egg, but are not so extravagantly wealthy that they don’t have a care in the world.

Imagine this: three people are subject to a 1 million dollar lawsuit and lose. Person A is fresh out of school and has a net worth of zero. Person B has worked and saved their entire life, and has a net worth of 1 million dollars which they are counting on for retirement. Person C has a net worth of 100 million dollars, from any variety of sources. Who is most affected?

Person A cannot pay the judgment, declares bankruptcy, and goes on with their life. They have years to build back up. Person C pays the judgment, takes a 1% hit to their net worth, and also goes on with their life. Person B sees their life savings wiped out and cannot recover. I would venture a guess that most working professionals are closer to person B than A or C. This is why its important to protect your assets from liability. Insurance helps with this, and the most common types of liability insurance are auto and homeowner’s.

Auto and homeowner’s insurance

Generally speaking, liability coverage should be appropriate to your level of net worth. This is a concept that becomes increasingly important as you accumulate wealth. Unfortunately, we live in a very litigious society. If someone sues you successfully, your assets can be seized to pay off the judgment.

We’ll take car insurance as an example. Every state has minimum requirements in terms of liability coverage; in my state (Texas) it is currently $30,000 for bodily injury per person in an accident you cause, $60,000 for total bodily injury if two or more people are injured, and $25,000 for any property damage you cause. This basic liability coverage is commonly known as 30/60/25, and many people buy the minimum in order to comply with the law.

But what if, God forbid, you’re at fault in a serious accident that sends the other party to into the ICU for two weeks? A night in the ICU can easily cost thousands of dollars per day. If the other party incurs $100,000 of medical bills, suddenly, the $30,000 bodily injury coverage is no longer enough. You’re on the hook for the other $70,000! You’ll probably get sued for the remainder, and perhaps even more, if a particularly zealous attorney finds out that you have enough money to cough up. All of your assets, including cash, savings, stocks, and real estate, can be at risk.

The property damage minimum can also be easily exceeded. The average cost of a new car in the United States is now $45,000. If you’re at fault in an accident and you happen to total someone’s new car, $25,000 in property coverage may not be enough. Many luxury and exotic vehicles cost in excess of $100,000. Can you afford to replace somebody’s Porsche or Lamborghini? Do you have sufficient liability coverage, or will the damage you cause in excess of your liability coverage wipe out your savings?

Of course, this is moot if you’re person A and don’t have any assets. People generally won’t waste the time and money to sue you if you have nothing for them to collect. But when you start accumulating net worth, much of your net worth is at risk to liability lawsuits.

Granted, I’m grossly oversimplifying all the factors that come in play to receive substantial judgment against you. Overall, it’s low probability occurrence. How often do car accident settlements exceed policy limits? Unfortunately, I could not find an answer backed up with data, although it’s rare. However, it can and does happen (there are some examples in the next section). Some carriers now offer maximum liability coverage limits of $250,000, $500,000, or more. As your net worth increases, you should also increase your insurance coverages as appropriate, eventually maxing them out.

I personally maxed out my liability coverage on both auto and homeowner's insurance. Unfortunately, this does mean higher premiums. On average, insurance policies do not pay for themselves. The insurance companies are the casino, and they will always have the house edge. This is okay! In this one instance, I don’t care about being frugal. It’s not the purpose of insurance to begin with. I don't buy insurance to try to save money; I buy it to mitigate financial disaster.

Umbrella insurance

What if you’re not satisfied even after you max out your auto and homeowner’s insurance? You’re not alone in your anxieties. Can you be found liable for millions? Of course! Since car accidents are so common, I’ll continue with this line of hypotheticals.

For example, a Bugatti Chiron costs over $3 million, and there’s at least one in Dallas. Now, the chances of me causing an accident on my commute, being at fault, where the accident happens to involve and total a $3 million Bugatti is pretty remote, to say the least. But it’s not impossible!

In this improbable, but not impossible scenario, even the max property liability of $250,000 or whatever my auto insurance carrier provides still won’t be enough! The idea that one accident can wipe out years or decades of hard work and diligent saving is terrifying.

And worse, If someone suffers an injury on your property or in an accident involving your car, you can be held liable for even higher amounts! In 2012, a company called ACE Private Risk Management published a list of recent liability judgments:

• A $49 million verdict in California resulting from a multi-vehicle crash in which a 21 year-old college student was left in a coma for one month and expected to require lifetime 24-hour care;

• A $31 million verdict in California to two defendants who were swept off a boat and subsequently injured by its propellers;

• A $29 million verdict in Pennsylvania for a four year-old boy who suffered a debilitating spinal cord injury while riding as a passenger in a vehicle involved in a head-on collision;

• A $21 million wrongful death action involving a 21 year-old female college student killed in an auto accident in Texas;

• A $20 million award in Florida for the death of a teenage male riding an ATV on a neighbor’s property without proper supervision;

• A $19 million award in New Jersey to a pedestrian suffering mild brain injuries and permanent scarring after being struck by a vehicle;

• A $14 million wrongful death verdict in Illinois involving a 22 year-old killed in an auto accident.

Of course, all of these examples are tragic and the courts decided that the victims or their families deserved every penny of their respective judgments. The likelihood of ever being liable for such amounts is very small, and these amounts will almost always come from something involving serious bodily injury. And you might think that something like this will never happen to you, but even if you are the most careful person in the world, are the most upstanding citizen, never commit any crimes, and always act with the best of intentions, accidents can still happen.

This is where umbrella insurance comes in. Umbrella insurance can cover additional liabilities after you have exhausted your auto or homeowner’s liability coverage. Umbrella insurance can also cover liability situations that don’t involve your home or auto at all. Your umbrella policy can serve as an additional liability shield before your personal assets are exposed. Umbrella policies generally provide millions in coverage, with some companies offering $5 million, $10 million, or even higher amounts.

Umbrella insurance might not make sense to people who don’t have much to lose to begin with. But at the risk of sounding like an insurance salesman, if you start accumulating substantial net worth and you worry about losing it, considering getting umbrella insurance after maxing out your auto and home insurance coverage.

Take advantage of liability-immune assets

If the above discussion sounds too gloomy, don’t fret. Again, while accidents are common, the risks of a massive liability judgment are low, and having adequate insurance will cover all but the most extreme outliers. There are also some assets which are immune to liability.

Retirement accounts

You should almost always max out your eligible retirement accounts, such as 401(k), 403(b), and IRAs for tax reasons alone. This is because your contributions are made pre-tax and reduce your taxable income. Not only do you pay less income tax, but the full contribution amount also gets to grow and compound in a tax-deferred account. And if your employer offers a match, you get free money on top of it!

But retirement accounts offer more than just tax benefits. Retirement accounts in the category of qualified retirement plans, which include 401(k) and 403(b) accounts, are also protected by a federal law known as ERISA against creditors, bankruptcy proceedings, and civil lawsuits. Even if a massive judgment against you in a lawsuit wipes away all of your other assets, your 401(k) is untouchable. It’s one of the safest places where you can keep assets.

IRA accounts offer less protection than 401(k) accounts, and protection varies by state. Some states, such as Texas, offer creditor protection for both traditional and Roth IRAs. Some states, such as California, however, offer only limited protection for IRAs, and ultimately allows the courts to decide how much of your IRA assets are exempt from liability. This site lists IRA protections by state.

The bottom line is that because retirement accounts, especially qualified retirement plans, offer so many benefits, including immunity to bankruptcy and civil liability, and because there are early withdrawal penalties for withdrawing money from these accounts before age 59.5 anyway, you should almost always max out these accounts and never withdraw money early from them unless you’re in dire circumstances! Your 401(k) is a sacred cow. It’s your last safe haven even if a cruel world decides to take everything else from you. Nobody else can touch it, so you certainly shouldn’t be touching it either!

Primary homestead protection

Retirement accounts are not the only assets immune to liability. Many states also provide a liability exemption for your primary residence (i.e., not vacation homes or rental homes). It’s important to note that this exemption is subject to local variations, and is not granted on a federal level. Some states protect your entire residence, but many states will only protect a fraction of of your primary home’s value against liability!

You can find a table listing primary homestead protections by state here. Note the huge differences in how much protection you get from different states!

For example, Texas is a state that grants unlimited liability protection for your primary homestead. On the other hand, Kentucky only provides an exemption up to $5,000 of your home’s value. This means that if you were in Kentucky and subject to a large financial judgment against you, you could be forced to sell your home as part of the court settlement, and end up keeping only $5,000. On the other hand, if you live in state which grants unlimited exemption on your primary homestead, you can rest easy knowing that as long as you own your home, nobody can take it away from you.

Of course, even if you live in a state that offers unlimited primary homestead immunity, this should not be construed as an encouragement to buy a home that you cannot afford under the guise of asset protection.

Life insurance and annuities

Finally, most states have laws that protect life insurance and annuities from liability as well, although again, the amount of protection offered differs by state. You can find a list here. I think that life insurance policies and annuities are subpar investments (for growth), but in this case they can be used to shield some assets.

Use federal deposit and investor insurance

Stay within FDIC limits

What if your bank goes out of business tomorrow, or suffers a bank run? It can happen, but you probably don’t stay awake at night worrying about whether the money you have in your bank is safe or not. But during the Great Depression, and prior to the creation of the FDIC, this was a legitimate concern for many people.

The FDIC insures bank deposits for up to $250,000 per account. If you happen to keep more than this amount in cash in an account, however, the excess is not protected. Since this amount is per account, if you had $500,000 in cash, you don’t necessarily need accounts at different banks. You can have 2 different accounts at the same bank, split your cash between the accounts, and still enjoy full FDIC deposit insurance.

The FDIC proudly states that "No depositor has ever lost a penny of insured deposits since the FDIC was created in 1933.” It goes without saying that you should never bank at an institution that isn’t FDIC insured (same for credit unions, which are insured by the NCUA). And most people probably don’t keep $250,000 in checking accounts. Regardless, there’s no reason not to stay within FDIC limits!

Brokerage accounts have insurance too!

The SIPC insures your brokerage accounts, for up to $500,000.

There are significant limitations to SIPC insurance. The SIPC does NOT protect the underlying value of your investments (i.e., from market losses). The SIPC only protects your assets against brokerage malfeasance or bankruptcy, without regard to what the market value of those assets are.

Also note that if your assets exceed $500,000, you cannot protect the excess just by creating another brokerage account. Instead, the SIPC uses a determination called separate capacity. As you can see, it is impossible to arbitrarily increase your protection limits for large investment portfolios, although married couples can still easily obtain at least 3 or more separate capacities if each person has an individual brokerage account and they also have a joint brokerage account, not to mention their retirement accounts, which are also separate capacities. This can mean several million in total assets protected by the SIPC.

Regardless of the SIPC’s limitations, the same advice for FDIC insurance applies. You should not invest with any brokerage institution that isn’t protected by the SIPC.

Be vigilant for scams

Scams of all kinds are everywhere, although the vast majority of scams are not specifically targeted at you. Instead, scammers tend to cast a wide net in their calls, messages, and emails, and focus their efforts on those who respond to the initial contact. The FTC has a website dedicated to various scams, including scams involving charities, jobs, prize winnings, student loans, and the list goes on and on. I strongly recommend you familiarize yourself with every single type of scam to avoid falling victim.

Some scams I’ve personally encountered are callers pretending to be in a position of authority, emails from friends who claim to be stranded or in distress somewhere, and of course, phishing scams which are ubiquitous. Do not answer unsolicited phone calls from the IRS, a financial institution, or any other government agency. Phone spoofers can make a call appear to originate from legitimate numbers. If in doubt, get the name and title of the person and call back the official number of the institution or agency on their website.

Use proper payment methods

It doesn’t matter what you’re paying for; whether it’s bills, groceries, online shopping, or even fines such as traffic tickets. Do not pay for anything with untraceable or irreversible payment methods. This includes payment via cash (unless face to face), gift cards, Paypal Friends and Family, or cryptocurrency, among others. There are many well-known scams where a company or government agency instructs you to pay for something with gift cards.

Sometimes, a private seller (for example, from an online ad or Facebook marketplace) will offer a discount if you pay them via Paypal Friends & Family. This is not automatically a scam, but be extremely wary. Sellers prefer Paypal F&F because the buyer cannot perform a chargeback and the seller also doesn’t incur fees. However, if you’re the buyer and you go this route, you have no recourse to dispute the transaction if the seller doesn’t hold up their end of the deal. Paypal will not investigate disputes if F&F was the payment method.

This is an example of a shopping site that has many hard to find products in-stock at prices at least 30-40% lower than normal. The site claims to have been in business since 2010 and even has fake testimonials. A quick lookup of the domain name shows that it was actually registered in late 2021. Upon checkout, the only accepted payments are those which offer little to no consumer protection, such as PayPal F&F or Bitcoin. Note that Paypal itself is a legitimate payment method, but F&F is not. This website is 100% a scam. Whoever runs the site will disappear with your payment, you will never receive the product, and the site itself will likely vanish within a few months.

Credit cards provide considerable consumer protection for purchases, in addition to various rewards. If you do not exceed your budget, pay off your credit cards promptly, and never accrue interest on any balances, (i.e., you can use a credit card responsibly), you should use a credit card for all of your purchases.

Be mindful of digital security

Digital security is more important than ever. Use unique usernames and unique, strong passwords on all accounts, if possible. Try not to recycle or reuse passwords. Make sure your personal email accounts have similar levels of protection, as account verification codes and password reset requests usually go to your email. Enable 2-factor authentication on all accounts that offer this feature. Your accounts are only as secure as the weakest link!

Familiarize yourself with common phishing scams, so that you don’t inadvertently give up your account information to unscrupulous parties.

Change all of your passwords periodically! Even if you have never fallen for a phishing scam and have never given anyone your usernames and passwords, it is highly likely that at least some of your usernames, personal information, and old passwords are floating out there from numerous past incidents of data breaches at various institutions and websites. Take a look at this list of some of the largest data breaches ever. This is especially troubling because some of these sites, such as Facebook, stored passwords in plain text for years.

If any of your assets are in cryptocurrency, crypto wallet security is paramount. At traditional financial institutions, you may still have some recourse in the event of account compromise or unauthorized use. However, with cryptocurrency, you are your own bank, and if your wallets are compromised, or even if you just misplace your seed phrases, your funds can be lost forever without any prospect of recovery.

Trusts, LLCs, and offshore asset protection

There is an entire industry of asset protection strategies through various legal methods. The most common of these are probably the use of limited liability companies (LLCs) to hold certain assets, commonly income-producing, but also liability-prone assets, such as rental properties. Here, the purpose of the LLC is to shield your personal assets from your business debt. If your rental business fails, you only lose your investment in the business, but your personal assets are safe. However, there are limits to LLC protection, because the shield doesn’t work in the other direction. You cannot, for example, put assets into an LLC and shelter them from a personal lawsuit. If you get sued, your ownership of your LLC is still considered one of your assets, and it can be taken away. Nonetheless, there may be creative ways to use LLCs for asset protection, and there are many companies out there (usually law firms) that advertise these services.

Another common asset protection vehicle is a trust. Again, there are limits to what a trust can do, but they can provide asset protection under specific circumstances. Every trust is a legal contract created by a grantor (yourself), funded by the grantor, overseen by trustees (which can include the grantor as well as others chosen by the grantor), and with beneficiaries designated by the grantor, who will receive the trust’s assets and income. Trusts are either revocable or irrevocable. With an irrevocable trust, you give up all rights of ownership to the assets that you transfer to the trust, and the trust also cannot be modified after it is signed.

Irrevocable trusts can be used for asset protection, but only in a certain sense. Your potential creditors can no longer seize assets you transfer to the trust, because you’ve already given up those assets. For example, an irrevocable children’s trust or 2503(c) is a type of trust allowed under the IRS code, section 2503. You can transfer assets into the trust for your children under the age of 21. These assets are immune to your creditors, because they no longer belong to you. The downside of such a trust is the same reason the trust provides protection: the assets no longer belong to you. Instead, they belong to the trust, and when your child reaches age 21, your child can demand the trust’s assets and use them however they please. You do not retain any control at all.

Finally, there are people who shelter certain assets offshore in jurisdictions outside of the U.S., for either asset protection (which is legal) or tax evasion (which is not). Admittedly, this is a topic which I know very little about. There are companies and services that tailor to very high net worth individuals and come up with these esoteric protection schemes. I imagine there’s very little overlap between these clients and the typical readership of my blog :)

If you are considering any of these more advanced asset protection strategies, you should probably talk to tax and legal professionals to help you navigate all of the complexities and avoid any wrongdoing.

Conclusion

I hope you enjoyed this article on asset protection. I think that most people would do well by simply not flaunting their assets, making sure they have adequate insurance, maximizing the use of liability-immune assets, and exercising common sense and good judgment. If you have other tips or thoughts about asset protection, please leave a comment! Thanks for reading, and happy investing!