October 18, 2016

Protecting Your Child's Inheritance In Case of Divorce

It's National Estate Planning Awareness Week! Our Wealth Advisors are answering your estate planning questions.
Nina Mitchell, Senior Wealth Advisor & Partner

Question:  How can I protect my daughter’s inheritance from becoming her husband’s property should their marriage end in divorce?

With the current divorce rate at 50%, it’s only natural that parents want to protect assets they transfer to their married children from becoming mixed up in a potential divorce. The two most common ways that this can be done are as an outright distribution titled and maintained in your child’s name only, or as a Trust. I also recommend that parents encourage their children to have a prenuptial agreement as added protection.

Your child’s inheritance is their sole and separate property so long as they take the proper steps to always segregate it from marital assets. 

What does this mean?  Your child should make sure any inherited accounts or property are titled in their name only, not jointly with their spouse, and continue to maintain the titling this way. If they commingle an inheritance with marital assets or title it in joint name, they cease to shelter it. Basically, your child’s spouse is now entitled to one-half of the inheritance.  

Unfortunately, separate property held by one spouse has a way of becoming marital property if the inheritance is not handled properly.   For example, when a couple buys a new home and uses previously inherited assets (i.e., assets that were titled in separate name) to purchase a home in joint name, the home is now deemed to be marital property subject to 50/50 division in the event of a divorce.  Similarly, any investments purchased with separate assets that subsequently become titled in both the husband and wife’s name convert to martial property upon divorce.  Bottom line, your child should keep inherited property titled in their name at all times and not as commingled assets in joint name. 

A more difficult scenario is when they inherit property that needs to be repaired and use marital assets to fix the property, or their spouse contributes “sweat equity” to do the work. As a married couple, any income earned is typically marital property. If they use (marital) income to repair the property your child inherited, it becomes more marital and less separate.  Let’s say, they take out a home equity loan to pay for the repairs, then use their income to make the monthly loan payments. They have transmuted a separate, inherited asset into marital property. We would strongly advise working with an attorney before going down this road. 

Transferring Assets Using a Trust

Rather than transferring assets outright, parents can set up a Trust to transfer wealth to their children. When assets are owned by a Trust, then by definition they are not owned by your children, or by extension, their spouses.  Your child’s spouse cannot pursue these assets in the event of a divorce.

Trusts are created in different forms with the differences typically relating to how the Trust’s assets are distributed to the beneficiaries. Generally, a spouse cannot claim rights to a Trust in a divorce, but courts in some states have awarded trust fund assets to the non-beneficiary spouse under certain circumstances. To protect the trust’s assets, make sure that your children understand the importance of maintaining those assets under the Trust's ownership to the fullest extent possible.

Finally, your children can set up a prenuptial agreement as a form of asset protection to ensure that separate assets remain as such in the event of divorce. 

Whether you are considering a Trust as a means to protect your child’s inheritance from their spouse, or to have your child establish a prenuptial agreement, we encourage you to consult with an experienced estate planning attorney so that your desired outcome can be accomplished.

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Nina Mitchell, Senior Wealth Advisor & Partner

With over 25 years of finance, tax and investment advisory experience, Nina advises an elite group of professional athletes, executives and high net worth individuals. She is a driving force behind Her Wealth, Bridgewater's initiative to empower women with financial knowledge, resources and confidence.