April 2008

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Protecting your assets in a divorce

Taxes are the most common threat to your financial security. The second most common threat? Divorce.

 More than 50 percent of all marriages in this country end in divorce, and that percentage grows to 60 percent for second marriages. In addition to being emotionally devastating, divorce can also be financially disastrous.

Divorce planning is not about hiding assets from a soon-to-be ex-spouse. Nor is it about cheating or lying to keep your wealth. Rather, it concerns resolving issues of property ownership and distribution before things go sour.

By agreeing on who gets what upfront, you can save money, time, and emotional distress in the long run. In fact, this type of asset-protection planning inevitably benefits all parties — except divorce lawyers, of course.

Divorce planning is also about shielding family assets from the potential divorces of children and grandchildren. Divorce statistics suggest it is an almost certainty that either a child or grandchild of yours will get divorced. Thus, for intergenerational financial planning, divorce planning is a crucial topic, unless you want to give half of your inheritance to the ex-spouses of your heirs.

There are ways to protect your children and grandchildren without making their spouses sign a prenuptial agreement.

CAN A ‘PRENUP’ PROTECT YOU?

A premarital agreement (also known as a prenuptial agreement, premarital contract, or antenuptial agreement) is the foundation of any protection against a divorce involving you. The premarital agreement is a written contract between the intended spouses. It specifies the division of property and income upon divorce, including disposition to specific personal property, such as family heirlooms.

It also states the responsibilities of each party and their children after divorce. Finally, the agreement lays out responsibilities during marriage, such as what each spouse can expect in financial support or which religion will be used to raise future children. The agreement cannot limit child support.

Even if you are successful in dealing with assets in a prenuptial or postnuptial agreement, you have more difficulty regarding income. A tax-beneficial nonqualified deferred compensation (NQDC) plan or nontraditional executive benefit plan can shield income. Such plans typically also reduce your taxable income (for future benefit), and therefore also reduce their income value for divorce purposes. Unfortunately, few physicians implement such plans, typically because they have not been advised about their benefits.

ALTERNATIVE TO MARITAL AGREEMENTS

If you have not yet implemented a pre- or postmarital agreement, an irrevocable trust can be a useful tool. Irrevocable trusts are effective asset-protection tools because you no longer own the assets; the trust owns them. You transfer your property with no strings attached. Because you neither own nor control the property, your creditors, including an ex-spouse, cannot claim the property.

Moreover, you can make children, grandchildren, and even future great-grandchildren beneficiaries of an irrevocable trust. However, even though they can benefit from trust assets, the trust can

Trusts can also protect family assets in case your children or grandchildren divorce without a prenuptial agreement.

By leaving assets to your children’s irrevocable trusts with the appropriate spendthrift provisions, rather than to them personally, you can shield your family assets. Of course, if the children take money out of the trust and use it to buy a home or other property, that property will be subject to the rules in each state. Let’s look at an example of a college-sweetheart marriage:

Rob and Janelle got married right out of college. Their romance turned sour within a few years, and Rob could no longer handle the physical and emotional abuse. However, during their three-year marriage, Janelle received a sizeable inheritance and used it to pay off the couple’s home.

When they filed for divorce, Rob’s attorney successfully argued that his time and labor on the house and the fact that he had lived in it (except when Janelle occasionally kicked him out and he had to stay at his mother’s) made half of the equity of the home (or $100,000) Rob’s fair share.

Though Rob and all of his friends will argue the $100,000 was a small consolation for what he endured, Janelle’s grandparents certainly didn’t intend for Rob to receive their inheritance.

What could have been done to avoid this situation? Janelle’s grandparents could have left her the inheritance through an irrevocable trust that only allowed her to take out a predetermined amount each year. In that case, she would have used the interest from the inheritance to pay the mortgage down each month and the corpus of the inheritance would have remained separate property and would not have been part of the divorce settlement.

In the short three years of their marriage, they would have had next to no equity in their home and Rob would have left the divorce with what he brought and his wounded pride — but none of Janelle’s grandparent’s life savings.

In a nutshell, a little planning can go a long way towards making sure a divorce doesn’t completely disrupt a family’s financial situation.

Whether you are single person considering marriage or already have a family and are concerned about losing family assets to the divorces of younger generations, divorce-protection planning is an integral part of your family’s comprehensive financial plan.

David B. Mandell, JD, MBA, is an attorney, lecturer, and author of The Doctor’s Wealth Protection Guide and Wealth Protection, M.D. Jason O’Dell is a financial consultant and author of Financial Planning for Physicians: Strategies for Saving Money and Securing Your Financial Future. They can be reached by phone at 800-554-7233 or through the Web site, www.ojmgroup.com.

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