As financial portfolios become more and more complex, financial trusts are becoming increasingly common. Why? Because trusts can be shaped to serve a variety of different purposes, and they can be drafted in a variety of different ways. These days, trusts are routinely used as tools for gifting, asset management, tax shelter and protection from creditors. They can be established while those involved are living, or they can be included in a will, to be established after death.
But, what role do trusts play in divorce?
Potentially a very big one, depending on your individual circumstances. Let me explain by discussing a few fundamental elements about trusts you need to know:
Assets placed in a trust established before marriage are typically treated as separate property.
As I mentioned a few weeks ago, before any woman gets married, she should carefully consider how to effectively protect her property rights and financial interests. For many single women, trusts are the most viable option –and remember: You do not need the approval of your fiancé (or anyone else, for that matter) to set one up.
For example, are you single, and a business owner? If so, you may want to establish a Domestic or Foreign Asset Protection Trust because it allows to you transfer the ownership of your separate property, including your company, into a separate trust. As a result, if you were ever to divorce, a trust like this could make the entire issue of separate property, and its appreciation, a moot point. How? Because once you have established a trust, the trust, and not you, would legally own your separate property, including your company.
In fact, according to Daniel S. Rubin, an asset protection planning attorney and partner with Moses & Singer LLP in New York City, the laws of certain domestic asset protection trust states, like Delaware, specifically provide that when the formation of the trust predates the wedding, the future ex-spouse has no claim against the trust property.
(If you have questions about how assets are divided in divorce, see my earlier article for a detailed discussion about the difference between separate and marital property.)
One note: A Domestic or Foreign Asset Protection Trust works for most entities –C Corporations, Limited Liability Companies, Limited Partnerships –but not necessarily for an S Corporation, since only certain types of trusts can own S Corporation stock. If your company is an S Corporation, you should discuss your options with a trust attorney who is experienced with asset protection trusts.
In some states, assets placed in a discretionary trust are also not considered as belonging to the beneficiary for the purpose of calculating alimony (but the laws regulating this vary from state to state).
That sentence may seem complicated at first, so let’s back up for a minute and take a look at how trusts work.
Trust assets are managed by a Trustee (a person or bank) for the benefit of others (called the beneficiaries). A trust can be drafted with a variety of different provisions in order to accomplish a variety of different goals (or perhaps, just one). In all cases, however, the Trustee must be meticulous and account to the beneficiaries about its action, and it must be fair and prudent in dealing with the trust and beneficiaries.
So, what happens if one spouse is named as the beneficiary of a trust, and that spouse benefits from the trust during the marriage? Can funds from the trust be included in the calculation of alimony? The answers to questions like those are not necessarily straightforward in every state, and a recent case decided by the New Jersey Supreme Court reveals just how complicated the issue can become.
In this particular instance, the wife, Wendy, was the beneficiary of an irrevocable, discretionary support trust established by her parents. During the marriage, this trust paid for certain expenses (such as real estate taxes on the marital residence), and when the couple divorced, the husband, Mark, petitioned the court to have the trust included in the calculation of alimony. In other words, since one of the purposes of the trust was to support Wendy, Mark wanted to use those funds to reduce the amount of alimony support he would be required to pay.
Initially, the court agreed with Mark and ordered the trust to pay Wendy an amount to cover the real estate taxes, plus a monthly sum ($4,000) – which worked out to be roughly equivalent to the monthly sum Mark was ordered to pay in alimony ($4,500).
But, the story didn’t end there. As it turns out, the New Jersey Appellate Division reversed the trial court’s order, concluding, in essence, the beneficiary of a purely discretionary trust cannot compel payments from the trust unless the trustees have abused their discretion. As is summed up in this excellent recap at Lexology.com, the Appellate court decided Wendy “did not have ‘the ability to tap the income source’ of the trust; accordingly, trust income could not be attributed to her for the purpose of determining alimony.”
The New Jersey Supreme Court upheld the Appellate Court’s decision.
According to Daniel Rubin, the laws of some, but not all, domestic asset protection trust states, provide that a claim for alimony cannot be enforced against a trust that was created prior to marriage. He notes, however, that these laws do not necessarily preclude the income of the trust from being considered in determining the appropriate alimony award.
Careful drafting of a trust’s terms and conditions will help protect funds from unintended beneficiaries.
The court case described above underscores how important it is to carefully design the terms and conditions of a trust. Even though the thought of divorce may be the furthest thing from your mind while you are drafting a trust agreement, it’s essential that you consider “the possibility” of a future breakup while you are establishing the terms. Will the trust assets be protected from your husband (or other unanticipated recipient) if you divorce? Are the proper safeguards in place?
Recently divorced women can use trusts and other techniques to protect their post-divorce assets from lawsuits and creditors.
Because our daily lives are filled with liability exposure, it makes sense to protect your assets from lawsuits and creditors.
Most people don’t realize how vulnerable they are. For example, one often overlooked liability exposure in our daily lives is driving. These days, driving has become so engrained in our culture that we seldom think twice about it. In fact, many of us spend hours every day on the road. We now eat in our cars, talk on the phone in our cars, conduct business from our cars. . . Driving is completely routine -until we have a near-miss, or worse, get into an accident.
And accidents are much more common than you realize. According to the National Highway Traffic Safety Administration (NHTSA), motor vehicle traffic crashes are a leading cause of death in the United States In 2010, there were an estimated 5,419,000 police-reported traffic crashes, in which 32,885 people were killed and 2,239,000 people were injured. That means an average of 90 people died each day in motor vehicle crashes in 2010—an average of one every 16 minutes.
Beyond the personal trauma, motor vehicle accidents typically have financial consequences, as well. I don’t want to be overly dramatic, but the truth is, every time you get behind the wheel, you can potentially injure or kill someone . . . and lose everything you own. Of course, it doesn’t help that your liability exposure goes up dramatically if you have teenagers or employees driving your cars –and it doesn’t help that there are so many attorneys working in the field of personal injury law who seem motivated solely by money.
I’m sure you’re familiar with these types of lawyers. They’re the ones with the hourly TV commercials claiming they can bring in large amounts of money for auto accident injury victims. How do they do it? Simple. These attorneys work under a contingency-fee arrangement, meaning they are paid a portion (usually one-third) of the money they are able to collect for the victims. So, they typically spend their time suing people who have significant assets. Since thousands of vehicle crashes happen every day, there are plenty of opportunities for these attorneys to cash-in, provided they put their energies into cases that will be the most profitable.
Celebrities know the drill. Brandy, the famous R&B singer, was dogged for years by lawsuits following a fatal car crash in LA. But, the same happens to “ordinary people” like you and me. For proof, see this table of the largest personal injury awards in New York State in 2010.
What can you do to protect your assets from auto injury lawsuits? My advice is to follow these four essential recommendations. Please:
- Drive safely. Don’t drive while you are impaired. Don’t drive under the influence of alcohol, drugs or medications. (Alcohol-related crashes account for about four in every ten vehicular deaths.) Don’t drive while you are sleepy, and avoid talking on the cell phone while you are driving, if at all possible.
- Review your auto insurance policy. Carry the highest auto liability insurance limits you can afford. The premium for $250,000 per person/$500,000 per accident bodily injury liability limits is about $15 to $20 a month more than that of $50,000 per person/$100,000 per accident limits. $15 -$20 is a very small price to pay for five times the amount of coverage.
- Buy a personal umbrella policy. A typical umbrella policy costs about $200 – $500 a year for $1 million of coverage. Personal injury attorneys will be extremely happy to collect that kind of money for themselves and their clients in most injury cases. After that kind of payday, odds are, they’ll leave you alone.
- Make yourself as small a financial target as possible. The less you own personally, the less vulnerable you are to certain lawsuits. So, design an asset protection plan and transfer your personal assets into well-structured private entities (like trusts). If you do, a personal injury attorney won’t be able to find many visible assets in your name, and consequently, he/she won’t waste too much time trying to sue you for additional money. Remember: If you have a $250,000 per person limit on your auto insurance policy, plus a $1 million umbrella policy, your insurance policy could provide a total of $1.25 million in potential award . . . and that $1.25 million settlement translates into a $400,000 paycheck for the attorney. Usually, an award like that is enough to satisfy and send him/her onto his/her next case. One important note: As with increasing your automobile liability insurance limits, an asset protection plan will only work if you establish it before your car accident. Once you’ve injured someone it’s usually too late to do anything.
Please make sure you review all of the options I’ve discussed with an experience asset protection attorney . . . and if you are in the process of divorce, consult with your divorce team about any trusts that are already in place and any areas where you may be financially vulnerable.
Female business owners, this is especially important for you. Divorce can all too easily put the existence of your business at risk… whether your husband was involved in the company or not, and regardless of who initiated the divorce. Learn more about how you can divorce-proof your business at my website BedrockDivorce.com.