Asset protection planning is a moving target. Practitioners must constantly be aware of case developments and changes in the law, which must be reflected in their plans. Nevertheless, some advisors operate by rote and give every asset protection client the same basic plan: a domestic family limited partnership (or a limited liability company) funded with the client's investments and owned primarily by the offshore asset protection trust. More thoughtful advisors employ numerous other domestic and international strategies. For instance, they make creative use of powers of appointment, noncharitable family foundations, purpose trusts, domestic and offshore life insurance products, offshore (primarily Swiss) annuities and imaginative combinations thereof.
But even the finest asset protection plan can be undone if transfers made to protect assets are deemed fraudulent. (See “Fraudulent Transfers,” p. 54.) Therefore, most advisors agree that it is better to have transfers supported by fair consideration and other factors beyond debt than it is to have transfers whose primary, if not sole motivation, arguably is removing assets from creditors' reach. That can sometimes be a heavy burden — which is one of the compelling reasons why more and more advisors are considering Swiss annuities for their clients.
Under Swiss law, life insurance policies (a term defined under Swiss law to include annuity contracts) that are recognized by the Swiss government agency overseeing such products (the Federal Office for Private Insurance Matters) are protected against debt collection procedures brought against the policy owner and are not part of the policy owner's bankruptcy estate. This is so even when a foreign judgment or court order expressly directs the seizure of a policy. For instance, if a U.S. bankruptcy court found that a debtor's Swiss annuity contract was a part of his estate for bankruptcy purposes and issued a finding to that effect, Swiss law (with one limited exception) would prohibit a Swiss court from issuing an order for the transfer or liquidation of the Swiss annuity in recognition of that foreign bankruptcy court order.1 One reason for this is that Swiss law dictates that the law of the issuing company's domicile, here Switzerland, governs any matter between the issuing company and the contract's owner (whether foreign or domestic.)2
The extensive statutory protection of Swiss annuities from owners' creditors depends on the identity of the beneficiaries and whether that designation is revocable or irrevocable. If the beneficiary designation is revocable, protection is granted only when the owner's spouse and/or descendants (which, interestingly, could include grandchildren) are named as beneficiaries.3 In this situation, an individual could enjoy the protection during a creditor's attack and, after the matter was settled, could revoke the beneficiary designation and liquidate the policy.
But if the contract owner is adjudicated bankrupt, Swiss law provides that ownership of the contract automatically transfers to the protected beneficiaries. Thus, upon a court's declaration of bankruptcy of the debtor/owner of a Swiss annuity, the debtor no longer owns the contract by “operation of law,” and any order or instructions from the debtor or on his behalf (including a court order) is ineffective.
An owner must make the beneficiary designation irrevocable if she wants protection but wishes to name an entity or someone other than her spouse or descendants as beneficiaries (as often happens with large policies whose proceeds would impact owners' estate plans.)4 She achieves irrevocability by (1) executing and delivering to the insurance company a written waiver of her right to revoke the beneficiary designation; and (2) physically delivering the policy to the beneficiary — or to the insurance company itself, with the beneficiary's acknowledgment.5
A foreign attack on a Swiss annuity generally would be in the form of an order from a bankruptcy proceeding or enforcement of a judgment against the contract owner. In either case, it would be expected that, among other things, a court would order the owner to liquidate the policy and turn over the proceeds, or to revoke a previous beneficiary designation so as to name as beneficiary the plaintiff or the trustee in bankruptcy. But if the previous beneficiary designation was irrevocable, the contract provision itself precludes the insurance company from complying with the request.6 If the designation is revocable, the anti-duress provision contained in Swiss law would apply, not only to the order to change the beneficiary, but also to the request to liquidate pursuant to the court's order.
TRUST AS BENEFICIARY
Owners can name an estate-planning trust as the beneficiary and — if the beneficiary designation is irrevocable — receive the same creditor protection under Swiss law — and perhaps additional protection offered by the trust itself. The ability to name a trust as a third-party beneficiary is particularly important. Many estate-planning practitioners were concerned about using Swiss annuities because for large annuities and/or annuities purchased by individuals with large estates, it is usually not sound planning to designate a spouse and/or descendants as the annuity's beneficiaries. So, while the asset protection aspect of the Swiss annuity was attractive, the perceived estate-planning limitations were a hindrance. It's clear, however, that an entity can be named as an irrevocable beneficiary of a Swiss annuity. This means that during the annuitant's lifetime, the contract is protected from creditors, and when the annuitant dies, the estate-planning concerns could be eliminated by naming the individual's estate-planning trust as the irrevocable beneficiary of the annuity contract. In such a case, it would be important that the trust, as beneficiary, was not revocable by the owner.
If an annuity owner wants to keep some control over the trust, he can name a trust that, although irrevocable, is nevertheless subject to a reserved special power of appointment held by the owner, or to a power held by another but exercisable only with the owner's consent.
FIXED OR VARIABLE?
When naming an irrevocable trust as the irrevocable beneficiary of the Swiss annuity contract, advisors must be keenly aware of the tax issues imposed by the individual's domicile jurisdiction. For instance, if a U.S. person names a trust as the beneficiary of his contract, the income tax deferral on the inside build-up of the contract funds will be lost unless the trust is a “pass-through” trust (a so-called “grantor trust”) as to the individual.7 Furthermore, the trust must be drafted so that it continues to be a grantor trust even after the individual's death.
Whether or not a trust is involved, there are other U.S. tax issues to consider. Swiss insurance companies, like most, offer annuity contracts that pay a fixed return on cash value (a fixed annuity) or a return based on the investment performance of funds held in the annuity and chosen by the contract owner from a list offered by the company (a variable annuity). Thus, the foreign fixed annuity not only contains virtually no risk (subject to the financial strength of the issuing company and no Swiss insurance company has ever failed), but also offers very limited growth and no tax deferral. For instance, if a U.S. person purchases a foreign annuity that is fixed in its return, she loses the income tax deferral, because U.S. law treats the foreign fixed annuity contract as an “original issue discount” debt instrument and taxes the “inside” income each year, even though the owner doesn't receive it every year.8
The variable annuity has investment risk but offers tax deferral and the potential for considerable growth, but only if it meets the requirements regarding control and diversification to qualify for the deferral. That is, to qualify for the U.S. tax deferral, the owner of the Swiss variable annuity must not direct or be able to direct the investments held under the annuity, and such investments must be adequately diversified.9 Fortunately, the ability of the owner to select categories of investments (such as selection among a group of mutual funds not available to the general public) will not violate the rule against “self-directed” investments. As to the diversification requirement, the tax regulations indicate what would satisfy the adequate diversification rule, and a special “look through” rule applies when qualifying mutual funds are purchased in a variable annuity.10 Thus, in the typical situation in which an owner wishes to have her funds in the annuity managed by “outside” professionals, the diversification requirement is usually not an issue.
It also should be noted that normally there is an excise tax of 1 percent that must be paid by a U.S. purchaser of a foreign insurance policy11 but because of a 1998 U.S./Swiss Double Tax Treaty amendment, there is no longer such an excise tax on the purchase of Swiss insurance or annuities. That tax remains in place for other foreign insurance or annuity policies.12
Swiss annuities' creditor protection could be lost if the Swiss fraudulent transfer rules apply, even though a spouse or an irrevocable asset protection trust may be the owner/beneficiary. Under Swiss law, the contract may be vulnerable to attack and the protective rules may be overridden if:
the contract was purchased or the beneficiary designation (in a way to secure protection) was made within a year of bankruptcy or seizure, or within a year of the commencement of an action that eventually leads to bankruptcy or seizure proceedings; or
the purchase of the contract rendered the individual insolvent.13
Note, however, that the creditor's action to seize the contract must be brought in a Swiss court, and the burden of proof is on the creditor. Further, the open period is extended to five years if the individual purchased the contract with the clear intent to prejudice creditors.14 In either case, however, the creditor must prove not only that the policyholder had the requisite intent, but also that the beneficiaries had knowledge of such intent.
Swiss annuity contracts have one more significant benefit that is worth mentioning. Recently, many courts, especially U.S. courts, have demonstrated a growing cynicism, if not a prejudice, against debtors who place their assets beyond their own control in foreign asset protection trusts.15 In one recent U.S. case, it was observed that U.S. courts “have, recently, cast a discerning eye at the substantiality of offshore spendthrift trusts in order to find the proverbial ‘chink in the armor.’” In light of this attitude, it may well be that the purchase of an annuity, which is not nearly as “foreign” or offensive to the courts as offshore trusts, may be regarded as more acceptable.
Certainly, a Swiss annuity (or an annuity from another jurisdiction with similar laws) can offer significant asset protection, tax and investment benefits. And when combined with a trust, it can offer considerable long-term estate-planning benefits, as well. Having an irrevocable trust as owner/beneficiary of the contract enhances the asset protection features and offers the opportunity to plan for distributions from the annuity (through the trust) to the individual and members of her family both during the individual's lifetime and long after the individual's death. In addition, these annuities offer the possibility of a fair-value defense to a fraudulent transfer attack and are far more likely to be accepted by the courts as a reasonable means of protecting investment assets.
- Note that two other jurisdictions, Austria and Liechtenstein, have protective laws similar to Switzerland over life insurance and annuities issued in those jurisdictions.
- Marc Sola, “Asset Protection Through Swiss Life Insurance Policies,” Asset Protection Journal, Vol. 2, No. 1 (Spring 2000), at p. 49.
- Swiss Insurance Act, Articles 80 and 81.
- Ibid., Article 79, para. 2.
- Ibid., Article 77, para. 2.
- Swiss Code of Obligations, Article 18.
- Internal Revenue Code Section 72(u).
- IRC Section 1275(a)(1)(B)(ii) and Treasury Regulations Section 1.1275-1(k).
- IRC Section 817.
- Treas. Regs. Section 1.817-5(f) and IRC Section 817(h)(4).
- IRC Section 4371(2).
- United States?Switzerland Income Tax Convention, ratified Oct. 31, 1997, Article 2, para. 2(b). Note that if life insurance is involved and there is a reinsurance element involved, the tax relief may be reduced.
- Swiss Insurance Act, Article 82, and Swiss Debt Collection and Bankruptcy Act, Article 285 et. seq.
- Swiss Debt Collection and Bankruptcy Act, Article 288.
- Federal Trade Commission v. Affordable Media, 179 F.3d 1228 (9th Cir. 1999).
Know the law
Briefly (very briefly), the elements of the fraudulent transfer rule provide that if the transferor made the transfer with the intention of hindering, delaying or defrauding the creditor from collecting on his claim, the transfer can be rescinded by a court (among other remedies).
Proving the transferor's intent is generally the key factor, but intent can be inferred if, for example, the transfer rendered the transferor insolvent or the transfer was for less than fair consideration. Thus, a debtor who exchanges property for funds or other assets of equal value is generally not seen as making a fraudulent transfer.
But the question is not always that clear. Suppose, for instance, that the assets acquired by the debtor in the fair value exchange is difficult or extremely complicated and expensive for the creditor to reach?
Although a few states have laws treating such a conversion of assets as tantamount to a fraudulent transfer,1 there is no clear answer to this, as every question of fraudulent transfer hinges upon the facts and circumstances of a particular case. For instance, while on the one hand, it certainly could be argued that a transfer of assets to a limited liability company would hinder the transferor's creditor from collecting against the new asset, on the other hand, there may be convincing circumstances aside from the debt issue that justified the transfer.
- See, for example, Texas Prop. Code Ann. Section 42.004.
— Alexander A. Bove, Jr.
Dreaming of Spring: After recovering from a nervous breakdown, Edvard Munch painted “Springtime” between 1911-1913. It sold for more than triple its pre-sale estimate, fetching over $6.2 million (3.156 million GBP) at Sotheby's “Impressionist and Modern Art, Evening Sale” on Feb. 5 in London.