- Understand the basics of how premarital assets are viewed versus postmarital assets.
- Prenups can make sense if you have children from a previous marriage.
- A domestic asset protection trust can give you certain benefits of both a revocable trust and an irrevocable trust.
Whose property is it, anyway?
A good place to begin is to understand some of the basics of how premarital assets that you bring into a marriage are viewed versus postmarital assets that are created or enhanced after a wedding.
In general, property you bring into a marriage—such as an inheritance from a family member—remains yours. Likewise, an inheritance that you receive during a marriage is also generally treated as your own property, separate from your spouse’s. That means in both cases a court is unlikely to demand that the inheritance be divided between you and your ex-spouse upon divorce. Other separate, premarital property commonly includes:
- Property you brought into the marriage
- Gifts to one spouse from any source
- Awards from lawsuits
In contrast, marital property (as the term suggests) is most of the personal property and real estate you acquire after you’re married—including income you earn from your job.
That said, there are multiple exceptions to this very generalized rule of thumb depending on the state you live in and other factors. For example, laws in “kitchen sink states” will include a person’s separate property with the couple’s marital property and consider all of it eligible to be divided up in a divorce.
Additionally, there can be the issue of transmutation risk. That’s when nonmarital assets become marital assets in the eyes of the courts because certain circumstances occur. Example: Say you and your spouse each have separate bank accounts from before your marriage. Such accounts are considered to be nonmarital assets—unless, that is, you contribute money to your spouse’s account after you’re married. At that point, the accounts become comingled and can be seen as marital assets that may be divided up between ex-spouses.
Related to all this is the concept of active assets versus passive assets. Assets that increase in value because you and your spouse took some sort of action are considered to be active. One example: Your spouse spent his or her money to improve the home you live in, which was already yours prior to the marriage. In that case, the house can become a marital asset.
In contrast, passive assets are those that increase in value because of developments that are out of your control—such as if a strong real estate market in your area boosts the value of your home, or if a bull market boosts your stock portfolio’s value. Passive assets that are separate usually stay that way.
Strategy #1: Prenuptial and postnuptial agreements
Of course, there are ways you can build a wall around your separate assets to better ensure they stay separate—and remain in your wallet if you divorce.
The option that immediately comes to mind for most people is a prenuptial agreement, which formally specifies which property you want to remain yours in the event you get divorced. Conversations around prenups can be emotionally charged. Some people say they foster suspicion and distrust going into a marriage, making divorce more likely. Others believe they help create clarity that ensures everyone understands the rules regarding who gets specific assets—which, in turn, can help the divorce process go more smoothly.
In general, it can make sense to consider a prenuptial agreement in situations such as these:
- You have children from a previous marriage. A prenup can spell out your expectations for how your children from a past marriage will be provided for financially from your estate. This can prevent an ex-spouse from claiming assets that you want those particular children to have.
- You have significantly more wealth than your spouse-to-be. If a significant financial imbalance between a couple exists—you are coming to the marriage with a significant amount of money you’ve inherited or earned, for example—a prenup can formally detail which assets will remain separate in the event of divorce.
- You expect to receive an inheritance. A prenup can help ensure that assets you receive from family while you’re married remain yours post-divorce.
- You are part owner of a family business. A prenup can help secure your interests in the family business that you bring into the marriage, as well as ownership interests you gain during your marriage. Without a prenup, you may need to hand over some ownership to an ex-spouse—and your family members working in the company might find themselves becoming unwilling partners with someone they’d rather not be doing business with.
Strategy #2: Domestic asset protection trust
However valuable a prenup may be, it may not be a bulletproof agreement. Prenups are often contested and can be overturned. Even if a prenup holds up to scrutiny, you can spend lots of money in attorney and court fees getting to that point.
That’s why some divorce experts point people to trusts, which can offer stronger asset protection in some cases.
Case in point: a domestic asset protection trust, or DAPT, which can shield assets from both creditors and ex-spouses. A DAPT is an irrevocable trust—once you place assets in it, you can’t take them back or revamp the trust itself. This puts the assets out of reach of most claims and excludes those assets from the category of marital property. However, unlike with typical irrevocable trusts, you can name yourself as a discretionary beneficiary of a DAPT—thereby giving you access to the assets in the trust and control over who is named trustee.
The upshot: A DAPT can give you certain benefits of both a revocable trust (such as control and access) and an irrevocable trust (such as protection from claims brought by an ex-spouse).
As of this writing, 15 states allow DAPTs—although you don’t need to live in one of them to set up a DAPT for yourself. The rules governing DAPTs vary from state to state. For example, some states allow trusts that prevent creditors, but not an ex-spouse, from getting to your money. So it pays to assess the options here.
Important: It’s imperative to create and fund a DAPT before the marriage for it to effectively protect assets. Setting one up during a marriage may be seen by a judge as a fraudulent transfer, thereby negating the trust. A good rule of thumb: Set up a DAPT at least six months before you tie the knot.
Strategy #3: Keep assets separated
As noted above, separate assets can easily become comingled assets with little more than a few online transfers between bank accounts. If you want to avoid turning a separate asset into a marital asset, consider taking steps such as these:
- Put your money in its own separate bucket. For example, don’t merge inherited money into an account that includes your spouse’s funds. Likewise, if you have your own premarital savings account, you risk turning it into marital property if you deposit your spouse’s money in it.
- Maintain titles in just one name. If you have a vacation home or another valuable asset that you acquired before getting married or remarried, keep the deed in your name—don’t add your spouse to it—if you’re concerned about protecting that property. That said, keeping homes separate can become tricky. For example, if you spend some of your separate inheritance on a home that benefits both you and your spouse, the house may be viewed as marital property in a divorce. The best bet is to consult with a trusted attorney if you’re unsure about how a financial move might impact the status of a property.
It’s likely that you and your spouse will have a series of difficult conversations over the years. It’s been said that love doesn’t happen by accident, but rather by deliberate intention. The same can be said about marriage and successful wealth planning. While you’re envisioning years of wonderful experience as a married couple, don’t forget to have some conversations about money that could potentially help you avoid a lot of confusion and fighting if things don’t work out as you hope.