There are several scenarios for married couples to consider in asset protection planning: To protect assets from creditors or potential lawsuits, to provide for a spouse and/or minor children after death, and to protect oneself in the event of a divorce.
When it comes to ownership of assets between spouses there are two legal systems in play in the United States: common law and community property.
In common law states, assets acquired during marriage but in only one spouse’s name are treated as separate property in regards to debts and/or lawsuits, but in the event of a divorce, are considered marital property in the division of assets. In common law states, it is good practice to hold assets in the name of the person with the least debts or who is least likely to be a party to a lawsuit.
California is a community property state. This means is that all assets acquired during marriage are considered community property. A creditor of one spouse can reach all community property. This extends to contracts signed by either spouse, as well as debt acquired prior to marriage.
Community property may be converted or ‘transmuted’ from community to separate property of either spouse by utilizing a transmutation agreement. But be careful—transmutation of real property will only be effective with third party creditors if it is in writing and properly recorded. The law of fraudulent transfers does apply to transmutation agreements, so transfers must occur prior to any collections or judgments to be effective in protecting assets. While transmutation agreements are generally desirable from an asset protection standpoint, they may have adverse tax consequences.
Another effective form of asset protection for a married couple is asset protection through a trust, which can provide a barrier of protection for trust beneficiaries in the event of death. When assets are owned by a trust instead of an individual they are more likely to be protected from creditors (as well as from any potential unwise decisions or spendthrift habits of the beneficiaries.)
A trust can also help blood relatives to protect property against divorce, thereby keeping “family” property in the family. Putting family assets (vacation property, family heirlooms, or “old money”) in trust will allow blood family—parents, and siblings—specify that assets owned by the trust can only be managed by blood relatives and descendents, thus keeping them out of the hands of spouses or ex-spouses.
For any married couple, the first step in protecting assets should be a prenuptial agreement. Prenuptial agreements may be drafted to be neutral as to the two spouses, but offer protection from third-party creditors.
Asset protection strategies will be different for every couple. In addition to the options covered in this blog, there are many other strategies available that will minimize exposure to risk.