Your life is complicated enough. Here are some ways to put your mind at ease.
In "Divorce in the Workplace" (June 2006), we described Jack Welch's woes and Gary Wendt's folly in their divorce situations, coterminous affairs and financial settlements. We strongly recommended a prenuptial agreement in order to protect the depletion of the executives' assets. Many executives marry long before they accumulate wealth and do not have such an agreement. Obtaining a postnuptial agreement is very difficult both financially and emotionally. The article generated a number of questions concerning how to protect your assets, which this article will discuss.
Prenuptial agreements remain the most effective tool in protecting one's assets, and the Paul McCartney-Heather Mills divorce will accentuate that point. The singer was offered a prenuptial by his wife, which he declined. He is reported to have $15 billion in assets, and under British law as opposed to U.S. law, his wife is entitled to exactly one-half or $7.5 billion.
As described in the Wendt decision, the judge applying U.S. law has pointed out that equitable distribution does not mean equal, but he still awarded $20 million to Wendt's wife in hard assets.
Protecting your assets is required not only because of divorce but under the Sarbanes-Oxley Act, civil awards against CEOs can be quite large. Here's are some ways to protect your assets:
* Personal liability rider, boring but necessary. Personal injury claims both around the house and in automobile accidents are covered by standard insurance, but usually the amount is minimal, such as $100,000. I advise CEOs and other high net worth individuals to obtain personal liability riders of $10 million to $15 million, which are available and will free you from worries.
For example, the CEO of a large utility in Atlanta was also chairman of the Salvation Army. He held a party at his house for board members who were on the deck when it promptly collapsed. Some individuals were paralyzed or severely injured, which led to suits seeking several million dollars in damages. Fortunately, the CEO was covered by the personal liability rider. Clearly, it's a good idea to increase your personal liability insurance and ensure your charitable activities are covered.
* Stuffing retirement plans. Put away as much as you can in your qualified plan because assets in qualified plans under ERISA are not subject to attachment. (Exceptions include the IRS and the spouse, to a limited extent, through a qualified domestic relations order). Take advantage of IRAs and personal savings accounts because under state law they are also exempt. Put your nonqualified plan into an irrevocable trust even though this causes immediate taxation. It is beneficial to the company because it funds its liability and gives it an immediate tax deduction. Sometimes the company will even gross you up for taxes (e.g., Marsh Mac). The trust can be established so that it is exempt from creditors. The bottom line? Stuff your qualified plans and nonqualified plans with as much money as possible.
* Homestead exemption. You should buy that mansion you always coveted. Remember O.J. Simpson, the football player? He got sued civilly for wrongful death and was held liable for millions of dollars many years ago. The plaintiffs have yet to collect a nickel while O.J. lives in his mansion, which under local state law is exempt from attachment by creditors. The new U.S. Bankruptcy Court has limited the exemption so that mansions will not be covered. However, it does not override state laws, most of which provide for the homestead exemption.
* Vacation home. You can buy a vacation home and then strip it of any value. You do this by taking on a 100 percent mortgage with interest-only payments and investing the assets in exempt property such as annuities or insurance.
* Domestic trusts. Alaska and Delaware have passed laws permitting personal trusts to be established, which will be exempt from creditors, and they are being used. Other states are following suit by enacting similar statutes. Many well-known estate planners prefer foreign trusts that have been court-tested while domestic trusts have not.
* Foreign trusts. Foreign trusts are a time-honored method of protecting your assets but not avoiding taxes (except for foreign citizens). The Cook Islands, the Isle of Man and Isle of Nevis all have passed very good laws that protect your assets from attachment by rejecting any U.S. judgments so that plaintiffs have to start the lawsuit all over again. There are many other protective provisions in these islands because anti-creditor trusts are a big business.
In a divorce case, foreign trusts also protect disclosure. Under foreign law, the grantor is not permitted to disclose anything concerning his foreign trust assets. Only the independent directorate in the Cook Islands or other islands can disclose this information, and they generally refuse all requests. There is nothing wrong with a foreign trust to protect assets. To this writer, it is preferable to a domestic trust because foreign trusts have been court-tested. However, the foreign trust has a bad "odor." This is true primarily because some individuals have used the foreign trusts to avoid taxes.
For example, Robert Wood Johnson IV, the successor to the Johnson & Johnson dynasty, and many other high net worth individuals used foreign trusts not only to protect assets but as a tax shelter "sold" by an accounting firm that was quite aggressive. These individuals are now paying back all of the so-called saved taxes with interest and significant penalties. To make matters worse, they were called to testify before Congress.
If done properly, the foreign trust remains an expensive but good way to protect your assets. As a word of caution, however, do not wait until the judgment is upon you or litigation has been filed. A transfer of assets can be set aside if it is made to defraud of creditors and usually is set aside if the transfer occurs too late.
* Investments and gifts to spouse. Often under state laws, annuities and life insurance policies are seen as assets and can be used as investment vehicles that are exempt from attachment by creditors. The former CEO of Tyco, Dennis Kozlowski, now convicted, transferred his assets to his spouse far in advance of the Sarbanes-Oxley Act and the subsequent lawsuits and judgments. Of course, the amounts become the property of the spouse, and while not subject to attachment, they are her assets; if there is a divorce, she can simply hold on to them. The CEO of Tyco did have such a divorce but the spouse, being a kind soul, provided him with funds for his defense and bail. Again, do not wait until it is too late or trust that your marriage is a good one.
The former head of AIG, Maurice "Hank" Greenberg, transferred assets to his spouse immediately after he was thrown out of AIG by the board and was sued by the Attorney General. Although he claimed that he was doing some late estate planning, creditors would have none of that. The subsequent publicity made him reverse the gift.
* Dynasty trusts. You have always wanted to make gifts to your children, who are now grown up. You can set up a trust for them, which will be exempt from attachment by creditors. Your children are free to make gifts to you, subject to transfer taxes, at any time.
You can also set up a dynasty trust, which avoids the generation-skipping tax by using the exemption and by picking the right state to create the trust, such as Delaware. The trust can literally last a lifetime for your children, grandchildren, great grandchildren, etc. However, pick your trustee carefully because these assets will not be returned to you. Your children will benefit and they can make gifts to you.
* Trusts: Protect against the trophy spouse. In addition to protecting assets, personal trusts can deal effectively with the situation of children from different marriages. For example, before a marriage is consummated, you could give away to your children from the prime marriage those assets which you wish them to receive. Older couples who decide to marry rather than just live with one another generally have either a prenuptial or post-nuptial agreement providing that the spouse waives all rights to assets. Thus, they can each leave their money to their children from prior marriages.
In addition, personal trusts can avoid will contests over those individuals who find youth with a younger mate. The Anna Nicole Smith case, of course, does involve a will contest, as does the case of another wealthy individual whose will was actually changed to leave a substantial amount of money to his housekeeper/mistress. In the case of Anna Nicole Smith, she claims that she has a different will, which is handwritten, than the former will. In the second case, the children are claiming undo influence.
Trusts for children can be very helpful in these cases. For the first case, a prenuptial agreement would have had the spouse waive all of her assets and had she contested the will, as Anna Nicole Smith is doing, there would be no assets. The same is true for the second situation; however, if the children receive any distributions, they will have assets to pay back to the spouse.
A prenuptial agreement, however, does not always protect your assets from the new spouse. He or she can waive rights under state law. A husband, for example, can make bequests to his wife in his will despite the prenuptial agreement.
There are many ways to protect your assets. The four most common used by CEOs are foreign trusts, the homestead exemption, the personal liability rider (which is a must), and gifts to the spouse, children and charity (foundation assets are not subject to attachment). A foreign trust will not prevent a spouse or creditors from attempting to obtain disclosure or suing you. However, they also know that collecting the assets by taking a trip to the Cook Islands is not going to be an easy one, and the settlement demands are usually lessened substantially. In the case of the homestead exemption and trusts, you can completely protect your assets.
A foreign trust will not prevent a spouse or creditors from attempting to obtain disclosure or suing you.
Arthur H. Kroll is CEO of Hartsdale, N.Y.-based KST Consulting Group and author of Compensating Executives.…