Should You Use a Trust or a Prenuptial Agreement to Protect Your Separate Assets From Your Spouse?

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Many couples enter into a marriage with some individual assets. Those assets are considered separate property and, generally, will not be divided if the couple divorces. Separate property also includes an inheritance or a gift made directly to a party during the marriage, provided it remains titled solely in that party’s name. Marital property is property acquired during the marriage and split in divorce using the principles of equitable distribution. A common problem that can arise is for a spouse to inadvertently convert separate property into marital property. Accordingly, spouses should look to available legal instruments, such as a trust or prenuptial agreement, to protect their separate assets.

A trust is an asset protection device whereby assets are held and managed by a trustee for the benefit of a beneficiary. In the marital context, if one spouse is the beneficiary of a trust, those assets are considered separate property absent special circumstances. Further, any income and principal paid from a separate property trust to a beneficiary spouse remains the separate property of that spouse provided it is maintained in an account in the name of the beneficiary spouse and not commingled with marital funds.

The benefit to a trust is that the assets are not owned by the beneficiary spouse and never become marital property even if they are used to purchase property that will be used by both parties. For example, the trust could purchase a home for the couple to live in and pay its expenses. Provided that the home remains in the trust and no marital funds are used to purchase, make mortgage payments, or maintain the home, the non-beneficiary spouse has no right to equitable distribution of the home. The title to the house is with the trust, not the other spouse.

One key issue in the use of trusts is to make sure that no marital property goes into the trust. If it does, the trust can be broken by the court to remove the marital property, and the marital assets will be subject to equitable distribution. An attorney and forensic accountant can trace the source of funds in a trust if there is the possibility that this has occurred.

Another important issue is that if the income from a trust is put into a joint account, used to buy a marital asset, or used to pay ordinary marital expenses, those amounts cease to be separate property and become marital property, subject to equitable distribution with one exception. Separate property contributions that are used as a down payment on or for capital improvements on an asset, such as real estate, retain their separate property character provided documents exist to trace said contribution. This is a different situation than the one mentioned above since there the trust owned the house. Any funds remaining in the trust or a separate account will continue to be the separate property of the beneficiary spouse.

As an alternative to a trust, separate property may also be protected in a prenuptial or post-nuptial agreement. These are used to help couples address financial issues that may arise during their marriage and in the event of divorce, separation, or death, although with respect to death, a Will needs to be drafted to effectuate the agreements stated in the prenup or post-nup in this regard. Prenups and post-nups are often used to protect separate property. One benefit of these documents is that they allow the parties to specify what income, assets, and debts will be “separate” without worrying about limiting access to money in a trust fund.

The downside of a prenup or post-nup is that both sides have to be involved in negotiating what will be separate property. That can result in conflicts or awkwardness. Sometimes one or both sides can feel uncomfortable raising or negotiating these issues and they do not address all the matters that should be discussed. In a trust, the nonbeneficiary spouse is not consulted.

If you are getting married or already married and want to protect your separate property with a trust or prenuptial agreement, talk with an attorney about the best option in your case. Please contact us to find out how we can help.

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