Usually, couples don’t get married and say to themselves, “let’s do this for five years then part ways.” After all, “diamonds are forever”, and not for just a few years. But with nearly half of all marriages in the U.S. ending in divorce, entering any relationship, whether it’s a business partnership or marriage, carries risks. Many couples will enter prenuptial agreements to protect what each one owns. But even prenups cannot protect you against surprises at the end of a marriage. Courts have the power to overturn the agreement and award your ex-spouse some of your assets.
Consider the following scenario. Let’s assume you and your spouse entered a prenuptial agreement ten years ago. But for whatever the reason, your marriage ends in divorce. Now, your former spouse claims half of your assets, even though you both signed a prenup when you both were engaged.
A divorce court can still find many reasons to declare a prenuptial agreement as null. The reasons can range from paperwork not being filed properly to spouses being mentally unfit to understand what they signed.
Let’s assume that in your case, the court declares that your prenuptial agreement was not drafted correctly due to filing errors and is now considered invalid. You thought that assets you acquired before marriage were safe from your ex, but the court decides otherwise and awards half of your real estate assets to your ex-spouse. In this instance, a trust may have protected you from your ex-spouse’s claim. It is vital that we emphasize “may have protected” as many factors will depend on the timing and specifics of the trust itself.
When you establish a living trust, you are taking the valuable personal property and transferring ownership of those items to another entity. This new entity is the trust, so it is the trust that owns the assets and not you. Trust assets are not subject to probate, increased tax liability, and in this case, claims from an ex-spouse during divorce proceedings. Your ex-spouse was once in a marriage with you, not the trust. A claim against the property in your trust is like an ex-spouse claiming half of your neighbor’s real estate during your divorce.
Although a trust is under the name of a trustee, which can be you, depending on the type and whether it is made revocable or irrevocable, the trust is always established for the benefit of named beneficiaries. Also, you can still enjoy the benefits of income-producing assets contained within the trust.
Keep in mind though, that income you receive from a trust is considered personal income which must be reported as such in your tax return. Moreover, this income can be considered when deciding spousal or child support. However, the fundamental point in this is that a trust, as a single entity, protects you from claims by others, whether that’s creditors or ex-spouses.
Business owners gain the most from establishing a trust for their business. On the contrary, business owners also have the most at risk if they do not have a plan in place to protect what they have acquired throughout their business careers. Without proper planning, business assets can be at risk during a divorce.
In the state of California, several types of trusts, including those initiated before the marriage, are safe from divorce. Other types of trusts include domestic and foreign asset protection trusts. Both types are beneficial for business owners and effective estate planning tools not only against divorce but also for preserving your wealth by reducing tax liability.
The main difference between these two is that in a revocable trust, as a trust owner, you can make changes and amendments to it while an irrevocable trust does not allow the trust holder to do so. It is worth mentioning that revocable trusts become irrevocable once the holder of the trust passes away or suffers incapacitation that limits him or her from making critical decisions.
For divorced beneficiaries, revocable or irrevocable trusts are of particular interest. A recipient of a revocable trust has no say for when distributions will take place. This decision is entirely up to the trust owner. For example, if you happen to be the beneficiary to your father’s trust, your ex-spouse cannot make any claims against the contents because you do not have ownership of that property. Legally, it is your father who owns them.
On the other hand, in an irrevocable trust, beneficiaries might have more control over distributions, all depending on the specifics the trust holder’s authority over how much power they hold. But in this scenario, if the beneficiary receives distributions or any income from the trust, it becomes the beneficiary’s responsibility. In this case, an ex-spouse may claim half of the income the trust distributes to you as a beneficiary.
Usually, it is easier to marry than it is to undo a marriage. Complexities in a divorce are even more of a concern for high-net-worth individuals. Business owners and those who have accumulated substantial wealth before and during their marriages need to have an effective solution for managing risk.
We hope we stay married to our partners for a lifetime, but despite our best efforts, marriages fall apart. As with all forms of risk, individuals must have plans in place for how they will protect their assets against failures, whether those be in a business or marriage.
While a trust can be a useful measure against protecting yourself in a divorce, setting one up or making changes to one, requires careful, detailed planning and the legal experience of an estate planning attorney who can look at your circumstances.
Have questions or need more information? Contact us to schedule a consultation