Divorce-Proofing Your Wealth

Safeguarding Your Assets from Potential Ex-Spouses

Premarital planning can be a sensitive, even taboo topic for individuals contemplating marriage. While premarital planning isn’t precisely “planning to fail,” “failing to plan” could have dramatic repercussions. Before you get married, keep an open mind about your options, especially if you have assets you aren’t willing to lose.

Lovebirds aside, one group is rarely shy about this topic: parents who want their family wealth to remain protected for their children in case of divorce. Parents, I’ve got you covered, too!

Marital Property and Divorce Laws: The Default Rules

What happens if you do nothing? Absent any overriding agreement, the law in the divorcing couple’s state governs how their property is handled. These laws define which assets are subject to division by differentiating between “marital property” and “separate property,” then specify how to divide the marital property between the former couple.

Separate property typically includes assets and debts an individual owns before marriage plus inheritances or gifts received individually and is generally protected from the ex-spouse. In contrast, marital property typically includes assets and debts acquired during the marriage through joint efforts or commingling and is generally subject to division among divorcing spouses.

States generally take one of two approaches when dividing marital property. Some states follow the “community property” approach, which considers marital property as jointly and equally owned by both spouses, absent certain exceptions and mitigating factors that warrant against the 50/50 ownership rule. The community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.¹

The remaining 41 states are “separate property” states that adhere to common law, which follows the equitable distribution of the marital property. Of course, “equitable” doesn’t necessarily mean equal 50/50 ownership. In determining an equitable split, the court may consider various factors, such as the duration of the marriage, each spouse’s contributions, and the financial needs of each spouse, to determine what is equitable. 

Prenuptial Agreements

A valid and enforceable prenuptial agreement (also called an antenuptial agreement or, colloquially, a “prenup”) can override the default divorce and marital property laws. A prenup is a legal agreement created before marriage that allows a couple to  redetermine how to deal with property in the event of divorce or death.

The couple agrees upon tailored terms for their circumstances; they may define what constitutes marital and separate property, determine who is responsible for debts, set guidelines for property division, contemplate alimony, agree to use mediation if a dispute arises, and address other matters of importance. Along with this control, prenups can ensure that both parties protect their assets, which can be particularly important for people with family wealth, business owners, or children from a prior relationship.

An enforceable prenup must satisfy the requirements set by applicable state law. While these vary widely among states, most require:

1. Full disclosure
   Before entering the prenup, both parties must fully and adequately disclose all financial information (assets, debts, income, etc.). Failure to disclose opens the prenup to challenges or invalidation. A comprehensive inventory is compiled and includes supporting documentation, such as financial statements, to substantiate disclosure and ensure transparency. Each party is encouraged to verify the disclosures, which might require additional expense.
2. Fairness
   Both parties need sufficient time to engage independent counsel and review, consider, and negotiate the prenup terms before signing to ensure a fair agreement.
3. Informed consent
   Each party should fully understand the agreement, its implications in case of divorce, and their rights and responsibilities under its terms.
4. Voluntary execution
   Both parties must voluntarily sign the agreement without pressure or coercion.

While prenups offer substantial protection, there can be drawbacks. Requesting prenups can be so sensitive that one 2022 survey conducted by the market research firm YouGov suggested that 25% of people would rather avoid marriage than broach the subject. Some individuals are uncomfortable disclosing their financial information or want to avoid the hassle and expense that disclosure entails. Prenups can also be tricky when there is a significant disparity in wealth or bargaining power. Finally, prenups aren’t 100% risk-proof: one may be invalidated if it contains unfair provisions or is deemed to have been signed by a party under duress or coercion.

So… if asset protection is important, but a prenup is undesirable or insufficient, what other options do you have?

Requesting prenups can be so sensitive that one survey suggests that 25% of people would rather avoid marriage than broach the subject.

Asset Protection Trusts

An alternative or supplement to a prenup is a domestic asset protection trust (DAPT). Only permitted in certain states, these trusts safeguard your assets from future creditors and financial risks, such as divorce, while allowing you to retain some control and access during your lifetime.

A DAPT is an irrevocable legal agreement between you and the trustee you appoint to manage the trust. As the creator, you set the terms for managing and distributing the trust assets, allowing you to structure your DAPT to meet your needs and goals. Depending on your applicable state’s laws, you can retain certain rights, such as being a discretionary beneficiary, influencing the distribution of income or principal, or acting as the trust’s investment advisor.

Once established, you transfer ownership of certain assets (e.g., investments, cash, a business, real estate) to the trust. There is a waiting period, determined by applicable state law, before asset protection attaches, so it is wise to establish and fund the trust well before any potential legal claims could arise.

While only 20 states recognize DAPTs, they allow nonresidents to create DAPTs; however, you will likely need at least one individual resident or corporate trustee in that state as your trustee. Proper trust administration, accounting, and record-keeping are also essential for protecting assets in a DAPT, so be sure your trustee understands and fulfills these fiduciary responsibilities. 

Complying with the applicable state’s legal requirements when executing and funding a DAPT is critical, but these rules widely vary. Who counts as a “creditor,” the requirements for forming a DAPT, and the creditor claim waiting period between the transfer and complete protection might differ among states. For example, in Tennessee, which is generally considered a favorable DAPT jurisdiction and where Baird Trust has an office, asset transfers properly and legally made to the trust are typically protected from creditor claims after 18 months from the date of the transfer, the shortest claims period offered by states; however, fraudulent transfers, existing claims, past-due child support, and past-due alimony are not protected from reaching Tennessee DAPTs. On the other hand, some DAPT states do not exempt divorcing spouses, alimony, and child support from their definition of “creditor” and may offer more protection in divorce.

For those dissuaded by prenups, DAPTs could be a satisfactory alternative.

• DAPTs do not require disclosure and offer significant privacy (a prenup filed with the court could become part of public record).
• They don’t require acquiescence by your spouse or betrothed, eliminating the expense and hassle of negotiating prenups and terms.
• DAPTs are not subject to time constraints like prenups – you could, in theory, sign and fund a trust right before your wedding (although, this is not generally advised).
• DAPTs can also be an excellent option for blended families or those with children from prior relationships.
• Finally, prenups only provide asset protection in divorce; DAPTs offer protection against many other creditors, not just potential ex-spouses.

DAPTs and prenups can also complement each other. For example, the prenup can set terms for dividing marital property while recognizing the DAPT’s assets as separate property. DAPTs can provide an additional layer of protection for specific assets (family assets or a business owned by one spouse) or in case the prenup is challenged and declared unenforceable.

Trusts for Children

This one goes out to all the parents, allowing them to proactively divorce-proof inheritances or lifetime gifts when passed to their children. This section also applies to anyone who wants to protect their intended beneficiary’s gift from divorce or other creditors.

As mentioned above, inherited and gifted assets are generally considered as separate non-marital property. Some courts, however, have shown a willingness to consider these assets in a divorce setting when splitting up property. This is especially so where an individual commingles their inheritance with marital property, such as where an individual adds inherited stock or cash into a joint account held with their spouse rather than keeping it in a separate individual account.

For individuals with this concern, consider passing wealth to your beneficiaries in trust. Placing inheritances (and lifetime gifts, where applicable) in a properly structured trust allows your loved one to receive financial support while safeguarding the family assets from divorce, lawsuits, bankruptcy, and financial mismanagement. The trust can also be structured to support your family long-term, passing any remaining trust assets after your child passes to grandchildren or other family members.

If the beneficiary can handle the duties and responsibilities of a trustee, they could even be their own trustee so long as distributions are limited by an “ascertainable standard” (a legal term of art that typically refers to “health, education, maintenance, and support”). In cases where a beneficiary cannot (or should not) act as trustee, another trusted individual or a corporate trustee such as Baird Trust could be named. It’s usually advisable to name a corporate trustee as a backup in the trustee succession provisions, particularly if longer-term trusts are involved, to ensure someone is available after everyone is gone.

Entering a marriage is momentous enough without having to worry about your financial future. If protecting your assets is essential to you, call your Baird Financial Advisor or attorney for further discussion on premarital planning.