High-income earners sometimes transfer substantial amounts of family assets to their nonworking spouses. Here's why this is a big mistake.
Occasionally, we come across situations in which a high-income earning spouse transfers a substantial amount of family assets to the nonworking (or lower risk) spouse. Usually, this is done to isolate the assets from creditors of the higher income earning spouse (usually in a profession with higher liability such as medicine or business). There are several reasons this is a mistake.
1. First, in some states, assets owned together are either partially or fully protected from creditors of a single spouse. For example, only half the assets are available to a creditor of only one of the spouses in many states if the assets are held "joint with right of survivorship." In some states, ownership "as tenants by the entireties" provides strong asset protection of the entire asset from challenge by a creditor of a single spouse. Moving the asset to the ownership of a single spouse opens the entire amount open to creditors of either that spouse or both spouses. Additionally, owning the assets in a revocable living trust provides absolutely no additional protection.
2. Second, if the spouse transferring the assets continues to manage the assets, a court may assume that this control in fact implies a form of ownership and may in fact result in a creditor of the former owner attaching the asset.
3. Third, divorce happens in up to 50 percent of marriages. A marital gift of substantial assets may end up being considered exempt as marital property in a divorce proceeding. There is case law in this respect with a wealthy individual being left almost penniless after making an "asset protection" transfer to a spouse who subsequently filed for divorce.
Note that there are other good ways to protect your assets and avoid the issues noted above. For example, under federal and many state laws, employer-sponsored retirement plans are given unlimited protection. Most states offer solid protection for most IRA accounts, and federal law offers even bankruptcy protection for rollover IRAs and for most traditional IRAs (up to $1 million in bankruptcy).
Many states have laws on the books protecting the cash value of life insurance policies and in annuities from creditors. However, not all states afford the same protections for these assets so it is always important to make asset protection decisions with your state law in mind. In addition, there are many facets of risk avoidance and risk sharing to consider. Finally, there are a series of protective structures available to help.
Lastly, it is important to remember that asset protection is not a replacement for insurance. Rather, it should be thought of as a supplement to your liability and professional insurance.
The seemingly simple process of gifting is rarely an equitable form of asset protection. This is a serious issue and should be approached with the help of a skilled estate planning attorney in conjunction with general estate planning. Like most things in life, it is best to start planning in this regard before a crisis arises.