Loans and defaults: Safeguard your wealth with creditor-proof investments

It's difficult to avoid taking a loan in this day and age. It is simple to get a home loan, a car loan, or an education or personal loan (against collateral). Even if you are fortunate enough to avoid loans, credit cards don’t let you leave the debt cycle.

If you pay your equated monthly instalments (EMI) on time, all is well. But if you don't, things fall apart.

For loans with collateral, the court authorises banks to sell the asset or security at an auction or otherwise, in order to recoup the loan. If the collateral is not enough to repay the loan, the creditor (say, a bank or an NBFC) may pressurise you to pay back the loan quickly, or they will ask the court for an attachment order. Additionally, if the borrower passes away, the creditor may file a lawsuit, which would be problematic for the borrower's family.

Thus, understanding the investing options that are protected from creditors is crucial. These are often referred to as creditor-proof investments. Courts cannot order the attachment of these investments, and a creditor cannot sell them at auction to recoup the loan.

The following are a few examples of investments that are immune from creditors:

1. Investment made through an irrevocable trust: all investments made through an irrevocable trust are shielded from lawsuits and creditors. Since these trusts are irrevocable, individuals can transfer their personal assets to them, but they are unable to receive assets from the trusts. Irrevocable trusts work in the beneficiaries' best interests and in accordance with the terms of the trust deed.

A court cannot attach a Trust unless the borrower's fraudulent intent is established in court, because a trust is an autonomous legal entity. As a result, consulting lawyers and professional accountants before establishing a trust is highly recommended.

2. Transferring rights on life insurance policies: when a life insurance policy is assigned, its rights are transferred to another individual. The policyholder who assigns the policy rights is referred to as the assignor, and the recipient of those rights is referred to as the assignee. The policyholder's right to the life insurance policy is revoked after the policy has been transferred from the assignor to the assignee. Accordingly, if the debtor defaults on a loan, the court cannot attach such assigned policies.

3. The Married Women's Property Act (MWP): the MWP act was created to shield married women from husbands, creditors, and even family members, regardless of their religion or caste. Women are allowed to purchase insurance policies under this law and name their children as nominees. Such policies are protected from court-ordered attachment. However, husbands do not have the right to benefit from such policies. Life insurance policies taken out by married men for the benefit of their wives and kids are also thus protected under this Act.

It is quite simple to enrol in insurance plans under the Act. You simply need to fill out a form.

4. Public Provident Fund (PPF): PPF offers tax-free returns. As of now the rate of return stands at 7.1 percent, subject to review each quarter. Additionally, contributions to PPF are tax deductible per section 80 C Income Tax Act. Taxes are not applied to any withdrawals from the fund. The PPF Act of 1968 prohibits courts from seizing PPF funds in order to pay creditors. However, income tax authorities have the right to seize it in case of default or fraudulent activity.

5. National Pension Scheme (NPS): Tier 1 NPS accounts cannot be attached by courts in case of a loan default, according to the Pension Fund Regulatory and Development Authority (PFRDA) statute of 2015.

6. Professional indemnity insurance: this shields professionals and companies from liability in case their clients suffer substantial losses due to their negligence or mistake. It is advised that businesses and professionals get professional indemnity insurance since a disgruntled client could sue the business even in the absence of any error, mistake, or carelessness on its part.

Investing in credit-proof securities is a respectable way to safeguard your hard-earned money. However, people must use these resources with proper investment goals in mind rather than solely to avoid creditors.