Wealth Preservation Strategies to Avoid 5 Major Risks

The wealthy have a lot, by definition.

However, this also means they have a lot to lose. So they take steps to protect their wealth.

Here are those steps, and what the rest of us can learn from them.

The 5 Main Risks to Wealth

Risk 1: Inflation

When you have wealth, you don’t keep a huge hoard of cash under the metaphorical mattress.

That would be foolish because cash is (almost) guaranteed to lose value.

In the last 25 years, inflation destroyed 48 percent of the value of a dollar! In the past 50 years, that loss was 85 percent and in the past century, it was 95 percent!

When trying to preserve multi-generational wealth, you have to think long-term.

Risk 2: Taxation

Even without a wealth tax, the wealthy are always hyper-aware of taxes.

• Personal income tax
• Corporate income tax
• Gift tax
• Estate tax
• Proposals of a wealth tax

The first four take away significant portions of high incomes. The fifth, should it ever be enacted, would take away chunks of existing wealth.

Risk 3: Personal Lawsuits

Bank robber Willie Sutton, asked why he robs banks reportedly answered, “Because that’s where the money is.”

From the perspective of the wealthy, they’re at a far higher risk of being sued than most people because they’re where the money is (along with the sense that the wealthy are seen by the non-wealthy in a negative light).

According to a recent Chubb report that surveyed 800 affluent Americans and Canadians, some of the liability risks include (with the fractions of the wealthy concerned about them in parentheses):

• Hitting a pedestrian (45 percent)
• Automobile accidents causing injury (40 percent)
• Assault or harassment allegations (31 percent)
• Accidents occurring to people working on your property (29 percent)
• Swimming-pool-related injuries (24 percent)
• Skiing accidents (20 percent)
• Boating accidents (17 percent)
• Libel, slander, or defamation lawsuits (14 percent)
• Dog bite claims (10 percent)

The Chubb report says that damage awards are increasing dramatically, and by way of explanation quotes Laila Brabander, Head of North American Personal Lines Claims for Chubb, “Economic damages historically were based on factors such as the extent of an injury and resultant medical expenses or past and future loss of income, but we are seeing a rise in non-economic damages, such as pain and suffering and PTSD, that overshadow actual economic losses.” Among other causes of higher settlement costs, Chubb counts third-party litigation funding firms that help plaintiffs and lawyers fund lawsuits in return for a share of settlements.

The problem is that many of these risks may seem like the homeowner’s insurance policy or auto insurance policy should cover them, but unless you add specific riders, they often don’t.

Risk 4: Professional/Business Lawsuits

Many wealthy people own businesses.

These businesses provide services or products.

If a client or customer chooses to, he or she can file a lawsuit claiming the business caused them damage. Some examples:

• A business-owned vehicle (e.g., a delivery truck or a car leased for the owner) hit them – since the liability coverage of the owner’s personal auto policy would exclude business use of the car.
• They slipped and fell on the premises of the business (e.g., because of black ice).
• The services provided included errors and/or omitted crucial information, leading to financial losses.
• The business infringed on their Intellectual Property (IP).
• A product sold by the business caused injury or illness.

In any of these situations, the client (whether a person or another business) can sue and potentially win a large judgment.

Risk 5: Failure of Financial Institutions

In recent years, we again started hearing of banks going under.

In these situations, someone of moderate means who has a savings account or Certificate of Deposit with a $10k or even $100k balance has little to worry about. The Federal Deposit Insurance Corporation (FDIC) will make you whole up to $250k.

But what if your account has a $1 million balance?

This is even likelier to be a concern in the investment world.

Here, the Securities Investment Protection Corporation (SIPC) protects cash and securities held by a brokerage up to $500k. However, the wealthy hold far more than $500k in assets, and these assets, e.g., mutual funds, may not be covered by SIPC at all.

How the Wealthy Protect Themselves Against These Risks

As you might expect, each risk requires its own solution or mitigation, sometimes more than one.

Mitigating Inflation

This joke was making the rounds in Israel in the 1980s, a period of high inflation and high taxes, “Q: How do you make a small fortune in Israel? A: Bring a big fortune from abroad!”

Nobody wants to work hard to build multi-generational wealth, only to have that wealth shrink to a tiny fraction by keeping it in cash.

Indeed, the wealthy know something important – if you want to avoid the long-term risk of inflation, you have to take on the far smaller long-term risk of so-called “risk assets” such as stocks.

The wealthy will thus invest their money in stocks and stock funds, direct ownership of businesses, real estate, and private equity deals.

Diversifying among different assets and asset classes, and holding them over the long haul ensures the invested wealth will grow over decades, far faster than inflation will eat away at the value of the dollar.

The rest of us can (and should) learn this lesson – to protect against inflation you need to invest in assets with positive (average) inflation-adjusted returns. 

Mitigating Taxes

There is a big difference between tax evasion and tax avoidance.

According to the IRS, the former is “The failure to pay or a deliberate underpayment of taxes.”

Tax evasion can literally put you in jail. As the UMKC website states, “… [Mobster Al] Capone would be brought to justice not for murder, extortion, or bootlegging, but for failing to pay his income tax.”

Tax avoidance, on the other hand, is (again per the IRS) “An action taken to lessen tax liability and maximize after-tax income.”

This latter is completely legal.

As federal district and appeals court judge Learned Hand wrote, “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands.”

And the wealthy take this message to heart.

Here are some they reduce their tax liability:

• Gifting: The wealthy reduce their taxable estate through gifting money and other assets to their kids – in 2024, the gift tax exclusion was $18,000. This lets a married couple gift $36,000 to each child every year. If the child is married, they can gift the same amount to his or her spouse.
• Life Insurance Policies and Annuities: Michael Rosenberg, RFC, CPFA, Managing Director and Founder, Diversified Investment Strategies, LLC explains how the wealthy use these products, “There are several strategies to protect and grow assets, including some innovative uses of annuities and life insurance. Many high-net-worth individuals, including athletes, leverage high cash-value life insurance not only to grow their wealth but also to shield it from lawsuits and taxes. Income from life insurance policies, accessed through policy loans, is tax-free for the client, offering the dual advantage of tax efficiency and asset protection. Annuities, on the other hand, provide an effective way to accumulate funds that may not be immediately needed for income, as the growth is tax deferred. This allows clients to build wealth over time with a measure of protection from current tax obligations.”
• The So-Called “Buy, Borrow, Die” Strategy: The wealthy don’t need to (illegally) evade taxes when the law allows them to side-step taxes. The “Buy, Borrow, Die” strategy helps them do precisely that. They buy assets such as stocks, bonds, real estate, etc.; then borrow money to cover living expenses, pledging those assets as collateral to receive preferred interest rates; then, when they die, the loans are paid off. Since loans aren’t taxed, they don’t pay taxes during their lifetime, and since the assets receive a step-up in basis, there’s no tax due when assets are sold to repay the loans. As long as the assets provide a higher annual return than the annual interest rates on the loans, the value of assets left to their family is higher.

Jon McCardle, AIF President and Founder, Summit Retirement Advisors expands, “Recently, inheritance has become a more significant contributor to wealth, with a noticeable increase in wealth transfers over the past few years. Inherited wealth generally arrives in the form of cash, investments, and sometimes real estate, such as a family home. The primary concern here is often taxation. To address these risks, straightforward solutions like life insurance and long-term care insurance are commonly employed. These tools provide an effective shield against the tax implications associated with inheritance, ensuring the wealth is preserved across generations.”

Lawrence D. Sprung, CFP®, Founder and Wealth Advisor, Mitlin Financial, Inc. agrees that long-term care can be an issue, “The possible need for long-term care can be a large risk, depending on the family, and can be mitigated. Although many wealthy individuals can afford a long-term care event, there are ways to protect against a reduction in assets. The wealthy look to stand-alone long-term care policies, hybrid life policies, and setting up accounts to fund future needs.”

McCardle continues, “As asset portfolios grow more complex, the nature of risks also evolves. The focus shifts from simple return on investment and probate concerns to intricate legal frameworks and courtroom battles. Taxation remains a constant challenge, but its impact scales with the complexity of the wealth and structures involved. This underscores the importance of tailored financial planning to navigate the intricate landscape of wealth protection effectively.

“When it comes to wealth protection and risk mitigation, our experience often shows a skewed perspective, particularly in the Midwest. In this region, wealth typically stems from farming, entrepreneurial ventures, and high-earning professionals like CEOs. 

“Despite the decline of traditional family farms over the last decade, the legacy of these operations remains strong in certain communities. This enduring legacy drives the use of FLPs, trusts, and long-term care planning. The goal is to retain the family farm within the family, rather than liquidating it for immediate financial gain. The risks associated with family farms are deeply rooted in legal and tax issues. 

“Given that many heirs may not have the means to purchase the farm outright, pre-arranged agreements are a common solution. These often resemble lease-to-own arrangements, where heirs gradually buy the farm from the current owners, who act as a bank, sometimes culminating in a final balloon payment or agreed inheritance terms.”

Unfortunately, most of the methods in this section, while completely legal, are not very helpful to most of us.

Protecting Against Personal Lawsuits

The Chubb survey found that nine of 10 wealthy respondents fear they’d be liable for outsized judgments against them if they’re sued. To protect against that, the wealthy often buy excess liability coverage, also known as umbrella insurance. This inexpensive coverage (e.g., a $10 million policy may cost as little as $1000) goes on top of their homeowners and auto insurance policies.

The benefit of such a policy is two-fold.

First, the obvious benefit is that if there’s a large judgment against the policyholder, the insurer will cover it up to the policy value.

Second, and perhaps more importantly, the policy gives the insurer a large stake in any potential judgment or settlement, so they will defend vigorously against the lawsuit.

Another method of protecting against lawsuits is to shield assets by owning them jointly as tenants in the entirety with a spouse (this depends on the state where they reside) or through Limited Liability Companies (LLCs), Family Limited Partnerships (FLPs), trusts, etc.

Of course, some assets such as 401(k) plans and (in some states) individual retirement accounts (IRAs) are already shielded by law.

If you’re not wealthy, your best bet is to make sure your homeowners and auto policies provide sufficient coverage (note that the state-required minimum auto liability coverage, while enough to avoid getting arrested for driving without insurance, is far from enough to protect most people from liability claims).

Protecting Against Professional/Business Lawsuits

The wealthy often own businesses. To protect these businesses against lawsuits, they set them up as separate LLCs, Limited Liability Partnerships (LLPs), corporations, etc.

While this does not protect against claims of malicious acts and/or professional errors and omissions, it does limit the reach of creditors to just the assets of the specific business. This is especially helpful in protecting their homes, cars, boats, and assets of other owned businesses.

On the flip side, assets owned by the LLC, LLP, or corporation that are related to its business activity may be protected against personal liability judgments.

To protect against professional errors and omissions, business owners will often purchase professional malpractice insurance (e.g., medical malpractice) and/or professional errors and omissions coverage (e.g., for consultants, accountants, engineers, investment advisors, real estate agents, etc.). Either as part of the above or as a separate policy, they buy business liability coverage.

McCardle shares, “Entrepreneurs and business owners take a markedly different approach to risk. They often use trusts, holding companies, limited partnerships, and LLCs to safeguard their wealth while they are alive. Their primary concerns are legal disputes, lawsuits, and divorces rather than sudden accidents or health issues. By transferring asset ownership into trusts and legal entities, they effectively isolate and protect various segments of their wealth. This strategy ensures that while one area might face legal challenges, others remain secure. For these individuals, conversations about tax implications often take precedence over discussions about investment returns, underscoring their focus on preserving and transferring wealth rather than consuming it.”

Even those wealthy individuals who don’t own a business may have potential liability if they serve as directors or officers on a board. Usually, these boards provide them with Directors and Officers (D&O) coverage.

If you don’t own a business, these risks don’t apply to you. If you do own a business (and, yes, a sole proprietorship that requires you to file a Schedule C is indeed a business), consult with a good insurance agent to make sure you’re appropriately covered.

Mitigating Failure of Financial Institutions

The main mitigation against possible failure of financial institutions (beyond the coverage provided by the FDIC or the SIPC) is to spread assets among multiple institutions, where some may be overseas. 

Mutual fund assets, which are usually not covered by SIPC, are protected by the Investment Company Act of 1940. The Act requires a mutual fund to be set up as a separate business entity from the fund manager. This means that should the fund manager fail, its creditors have no access to the fund assets.

Most people should be covered well enough through the FDIC, SIPC, and the Investment Company Act of 1940 without having to take any special steps.

The Bottom Line

The wealthy are very savvy about protecting themselves and their assets from a range of risks. 

They do so by hiring good attorneys, accountants, and financial advisors who help them set up legal entities and trusts, purchase insurance policies, implement advanced tax avoidance strategies that take advantage of legal loopholes, etc. 

As David Berns, Investment Advisor, HD Money Inc. says, “Our wealthy clients do not take on risks that aren’t necessary for their goals. There are many new and innovative products out today that we can use that were not available to us even five years ago. We take a balanced approach and use buffered strategies to help mitigate downside risk.”

Chris Boyd-Witherspoon, Defensive Retirement Strategist, American Heritage Financial sums things up, “When it comes to wealth preservation, the best advice is to diversify not just your investments but also your risks. Umbrella insurance, asset protection trusts, and LLCs can all play a role in creating a shield. To offset inflation, the wealthy often rely on inflation-proof assets like real estate, equities, or private investments. The key is focusing on growth assets that historically outpace inflation.”

All of the above strategies are legal and technically available to anyone, but many only work and make financial sense if you’re wealthy. Still, don’t skip those that do make legal and financial sense in your specific situation.

Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.