Volume 2, Number 2
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Domestic Asset Protection Trusts: An Alternative to Prenuptial Agreements
Divorce is a cruel reality in this day and age. More than half of the marriages in the U.S. end in divorce. In the absence of proper planning, a spouse in a dissolving marriage may be entitled to an equitable distribution of marital property, which includes business interests, gifts, inheritances, employment income and other assets held prior to the marriage. Thus, it is imperative for couples contemplating marriage to find ways to clearly delineate their wishes with regard to their income and assets prior to the “big day”. If not, such decisions may be left to the wide discretion of judges and the court system.
As such, in past years, both men and women concerned about protecting assets obtained prior to the marriage from future spouses use prenuptial agreements. Although prenups serve a certain purpose, there are many personal and legal issues that deter couples from executing prenups. First, due to the stringent validity requirements of prenuptial agreements, these agreements must be drafted very carefully. If not done correctly, prenuptial agreements are open to challenges and may be held invalid. Each party must be represented by independent counsel to avoid any accusations of duress or coercion. Also, the agreement must be fair at the time of execution and enforcement, which, in most instances, the “fairness” of the document is determined by a judge or a jury. Depending on the state, anywhere from 10% to 80% are completely disregarded in a divorce proceeding. Second, asking one’s future spouse to enter into a prenuptial agreement may cause difficulty in some blossoming relationships. Many people erroneously believe that executing a prenup means that they do not trust their future spouse or expect to be divorced. As such, many couples shy away from such agreements. Lastly, the requirement of full financial disclosure also can deter couples from executing a prenup. Although couples promise to share their lives together upon marriage, many feel uncomfortable sharing their total net worth.
Due to the issues and problems surrounding prenuptial agreements, many practitioners have turned to alternatives to protecting assets obtained prior to marriage, such as a domestic or foreign asset protection trust. However, due to the mounting costs of establishing and administering foreign asset protection trusts—coupled with the fact that clients are uncomfortable with sending their assets offshore-- utilizing a domestic asset protection trust in a state, such as Delaware, that permits self-settled trust has become a much more popular vehicle for protecting one’s assets from a future spouse.
Domestic asset protection trusts (DAPTs) are trusts that protect assets from creditors, which include by definition a future spouse. Additionally, a DAPT allows the settlor to name him or herself as a potential beneficiary—hence the name “self-settled” trusts. Beyond its utility as an estate planning device, asset protection trusts are effective against a settlor’s future spouse and other creditors provided the trust settlement does not violate applicable fraudulent transfer law. Furthermore, in establishing a domestic asset protection trust, there is no requirement that the settlor of the trust disclose his or her plans to create a DAPT or the assets with which he or she will fund the trust. As such, a soon to be married individual can establish a DAPT in a state permitting such trusts and, upon the dissolution of the marriage, shield those assets from any equitable distribution. This technique is very appealing to many individuals who, although would like to protect their assets from their future spouse or the widely unpredictable discretion of a judge, would like to do so quietly and without any hassle.
As with any estate planning technique, a domestic asset protection trust, although relatively easy to establish, must meet certain criteria to be valid. A DAPT: 1) must be irrevocable or unchangeable; 2) should appoint a trustee with the discretion to administer the trust; and 3) must appoint a trustee, whether corporate or individual, that is a resident of the jurisdiction in which the trust is formed. Additionally, a DAPT must contain a spendthrift clause, which restricts the transferability of a beneficiary’s interests in the trust property, whether voluntary or involuntary, before the trustee actually distributes the property to the beneficiary. However, in exchange for restricting the use of their assets, those who establish DAPTs receive several benefits. First, because the assets placed in the DAPT may be viewed as the property of the trust, the settlor may protect those assets against claims made by future creditors, including a future spouse. Additionally, unlike jurisdictions without asset protection statutes, a grantor may create a self-settled trust, which permits a grantor to retain a beneficial interest in the trust while protecting the assets from future creditors. Thus, a potential wife or husband can establish a domestic asset protection trust that is fully discretionary, receive financial benefit from the trust as needed during the life of the trust and protect those assets from a marriage that came after the creation of the trust.
With such power and protection afforded by DAPTS, practitioners and advisors are remiss if they do not raise the subject of these trusts with their clients when discussing premarital planning. If the subject of a DAPT is not raised, an advisor runs the risk of having a client’s prenuptial agreement held invalid or the possibility of a client losing his or her future spouse to the “You Don’t Trust Me” argument. Alternatively, DAPTs can be a safe and less invasive way to protect a client’s assets, while at the same time preserving the trust and love all clients desire when contemplating tying the knot.