“My daughter is getting married. Does she need a premarital agreement?”
Estate planning attorneys hear this question more and more frequently – generally from clients concerned about the assets they plan to leave their children. Numerous wealth transfer predictions estimate that trillions of dollars will pass over the next decade from a generation that earned the money to their children who did not earn it. Parents (and grandparents) may want to assure that the inheritance the child receives, whether cash, real estate, a stock portfolio or an interest in a family business, will be stewarded carefully. Parents usually hope that the inherited assets will ultimately pass at the child’s death to the child’s children or grandchildren rather than to a child’s surviving spouse, however much they may like the intended spouse. However, absent an agreement, a surviving spouse at death has rights of inheritance, varying from state to state, in the assets of the deceased spouse. The impact of divorce on the assets is another realistic concern. Most people have experienced, directly or indirectly, divorce disputes that dissipated assets. Premarital agreements (PMAs) are increasingly used by couples as an effective way to address these concerns. However, a person seeking asset protection for an inheritance he/she is passing on to a child also needs to consider whether leaving the inheritance in trust for the child will provide some additional desired protection. In many cases, the answer to the question is that in addition to advising the child to obtain a PMA, the parent should discuss with his/her estate planner leaving the adult child’s inheritance in trust. A carefully designed trust can provide additional protection not provided by a PMA alone.
Protections provided by a PMA
State laws as to how assets are divided at divorce vary from state to state. State laws also vary substantially as to what a surviving spouse can claim from a deceased spouse’s estate. A PMA can displace state laws and put in place agreed rules about each spouse’s rights in property at death and divorce. These rules can provide substantial protection for inherited assets if the child’s marriage fails or if the child predeceases his/her spouse. A premarital agreement may be advisable for other reasons also, such as protecting a family business or reducing the costs of divorce if a marriage fails. See “Premarital Agreements and the Business Owner” July 30, 2012 and “Premarital Agreements and the Young Couple” April 6, 2015 for a discussion of many of the issues relating to premarital agreements.
A PMA may not be the complete answer to a parent’s concerns about protection of a child’s inheritance. The child may not agree to enter into a PMA. Even if the child is willing, there is no guarantee that the couple will both agree to go through the frequently challenging process to arrive at an acceptable PMA that protects assets as completely as desired. See “Getting Off to the Right Start: A Collaborative Premarital Agreement” May 26, 2016 for a discussion of some of these issues.
Further, it may not protect the child’s inherited assets if:
- The PMA is subsequently amended or terminated by agreement of the parties, either voluntarily or under pressure;
- Pressure from the other spouse causes the child to make transfers of property, use inherited property to purchase property titled in the name of both spouses, invest in the other spouse’s business venture or otherwise allow the other spouse access to the assets in contravention of the intent of the agreement;
- The child fails to pay proper attention to how his or her inheritance is titled, invested and spent;
- The child becomes liable for expenses or debts of the marriage or has other creditor problems created by the child’s spouse, for instance from the spouse’s business ventures or other activities.
Role of an irrevocable trust in protecting an inheritance.
A parent who wants the highest level of protection for an inheritance he/she is leaving a child, in addition to encouraging a PMA, should consider an irrevocable trust to hold the child’s inheritance rather than leaving the inheritance to the child outright. An irrevocable trust can provide valuable protections for an inheritance that a PMA alone cannot. At a minimum, having the assets titled in a trust: (1) segregates the assets to prevent intermingling them with other assets of the marriage; and (2) clearly identifies the assets as the inherited property of the beneficiary-spouse. Additionally, in most states, a properly designed irrevocable trust established by a party other that the child, can protect the assets from the child’s creditors. In most states, assets in a trust are insulated from property claims of a divorcing spouse and trust can protect the inheritance from claims of the surviving spouse at the child’s death.
Designing the irrevocable trust.
The level of protection desired by the individual is key to designing a trust. Trusts are very flexible instruments. The client needs to discuss with the estate planning attorney specific concerns and goals and understand the various options for trust design. The trust can specify what control the child has over the trust assets and whether or not the child will be the trustee or a co-trustee to manage and invest assets and make decisions about distributions from the trust. The child may be given the power to direct all or a part of the trust assets into further trust for the surviving spouse so that the surviving spouse can be provided for but cannot dissipate the assets after the child’s death. Along the spectrum of how much control the child has over the trust assets, generally the less control the child has, the more the assets are protected inside the trust. As a result, the parent will need to make decisions about the balance between protecting the assets and giving the child more control over the assets in trust.
Estate tax protection.
In addition to asset protection goals, a trust can protect the assets against estate taxes at the child’s death, maximizing what will pass to the child’s children. Again, the client and the attorney need to discuss the client’s goals, the child’s situation, skills and needs, the amount of the inheritance, the type of assets ( a stock portfolio, real estate, cash or an interest in a business), and the estate tax exposure of the assets and then design the trust for the client’s particular situation.
See “Premarital Agreements and Trusts” October 22, 2015 for more information about design of trusts to protect an inheritance.
Using both a PMA and a trust provides highest protection.
Both premarital agreements and trusts have valuable roles to play as a means of protecting a beneficiary’s assets. Neither one alone can provide the protection offered by the other. When the parent and child share a desire to protect a potential substantial inheritance for the child, and the child’s children, from future claims of a spouse, they will attain maximum protection by using both a trust to hold the child’s inheritance and a PMA.