As Marriage Draws Near, Consider a Prenup or a Trust

Investment Quarterly — Fall 2013

As a wedding approaches, finances are sometimes the last thing on a couple's mind. However, financial issues associated with marriage should be addressed—well before the ceremony actually takes place. This consideration is true for individuals with children from a previous marriage, but also applies to those with significant assets or the prospect of such assets, as well as to wealthy families whose children or grandchildren are about to marry.

Prenuptial Agreements: Laying The Groundwork

When a marriage ends, whether through death or divorce, one spouse generally has certain rights to the other's assets under state and/or federal law. Drafted properly, a prenuptial agreement can specify the financial arrangements in case of a possible divorce and at the death of either or both spouses. This contract permits a spouse to retain assets that otherwise would be relinquished to a spouse in a divorce settlement. In addition, a prenuptial agreement can provide that assets one spouse has brought into the marriage, or has subsequently acquired, will be inherited by individuals other than the surviving spouse.

Moreover, a well-prepared prenuptial agreement can help clarify financial matters and avoid future misunderstandings between spouses. An effective prenuptial agreement requires full disclosure, on both sides, and preferably separate legal representation, so each spouse will go into the marriage knowing about the other's finances and is more likely to have realistic expectations.

Prenuptial agreements can be flexible. The provisions can even change after a designated period of time, for example, five or 10 years of marriage, or upon the happening of certain events, such as the birth of a child. What's more, these arrangements are not absolute: A wealthy spouse often decides to leave more to a surviving spouse than the amount proscribed in the prenuptial agreement.

As an added benefit, working out the terms of a prenuptial agreement can generate a discussion about future financial goals and strategies between spouses-to-be, setting the stage for fewer disputes about money matters later. Nevertheless, in some cases, the topic and negotiation of a prenuptial agreement can be difficult.

Straight Talk And Prenuptial Agreement Challenges

Despite certain advantages, prenups have drawbacks and may not be ideal for every situation. Prenuptial agreements cannot apply to child custody issues, for example, and they may not necessarily hold up for child support arrangements. Challenges to the document are always possible, so a prenuptial agreement needs to be created with care, with both parties fully disclosing their assets, and with neither signing under duress.

Further complicating matters is the fact that certain assets are afforded spousal protection under law, such as retirement assets, so even a properly prepared prenuptial agreement cannot cover all assets. For example, federal law provides spouses with certain rights to employer-sponsored retirement plans, such as 401(k)s. These rights cannot be legally waived before the wedding, because the law permits waivers only by spouses. Therefore, the prenuptial agreement typically provides for the couple's agreement to waive their rights in such plans and to sign a separate waiver document after the marriage. If the waivers are signed after the wedding, they generally will be enforceable. However, the agreement to sign in and of itself is insufficient to effect the waivers.

Finally, for some, discussing a prenuptial agreement can be very emotional and stressful. Given that the agreements are much more commonplace today, raising the subject may not be met with as much concern as in the past, but it still becomes a negotiation at an otherwise exciting and happy time.

Trusts: Another Way To Protect Your Assets

As an alternative, the spouse-to-be with ample net worth or an expectancy may be able to sidestep the need for a prenuptial agreement by doing some estate planning before the wedding to keep certain assets in the family. Parents and grandparents of the betrothed can do the same. Trusts are one vehicle to achieve some asset protection. Trusts can be established with or without the knowledge of an intended spouse or in-law. Moreover, trusts do not have the same requirements as prenuptial agreements. They can be drafted without full disclosure of assets, and without independent legal representation for the bride and groom. A trust can even be executed on the eve of the marriage ceremony without fear of being overturned. But keep in mind that there can be consequences to a relationship if the spouse learns of these actions after the fact.

Trusts can be used in several ways as a substitute for or supplement to a prenuptial agreement. For example, if an individual is willing to give up some control of his or her assets, he or she can create and fund an irrevocable trust before the marriage and be a discretionary trust beneficiary. This trust can also provide for the ultimate disposition of the trust property to individuals other than the new spouse. If carefully drafted and administered in conformity with the law of certain states, the spouse should not be able to have access to these trust assets upon divorce, or upon the death of the spouse who created the trust. However, to accomplish this result, the trust creator has also severely limited his or her own access to these funds. Practically, this alternative is not often appealing to a spouse-to-be unless there is significant wealth involved so setting aside a nest egg is not a hardship, or there is a specific asset, such as an interest in a family business, that is important to protect.

Affluent parents or grandparents, meanwhile, can consider transferring assets to a trust instead of making outright gifts to the bride or groom. They also can provide in their wills (or revocable trusts) that inheritances are in trust rather than outright. If carefully drafted, in many states these trust assets should not be at risk in a divorce or at death. As a bonus, if family wealth is the primary catalyst for the prenup, having these assets out of the mix may put the intendeds on a more equal footing when addressing the prenup and therefore ease the discussions.

Individual circumstances and course of conduct are always a consideration in divorces, however, and none of these trusts are necessarily "safe" in settlement negotiations. If a child or grandchild consistently receives distributions from a trust—even a trust established by another, using funds that never were owned by the bride or groom—a court may presume similar future distributions will be made and deem the assets available when determining the split of assets, maintenance and child support obligations.

Prudent Planning

Both prenuptial agreements and trusts can offer value to individuals preparing to get married. Before the wedding, those with significant assets (or future expectations) need a comprehensive plan, something a professional such as a financial advisor, tax professional, family law attorney or trust and estate attorney can help assemble. Such planning—whether it is executed through a prenuptial agreement, a trust or both—may be vital not only for those planning to marry, but also for their parents and grandparents who are seeking to preserve family assets for future generations.

This material is presented solely for informational purposes and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation or solicitation to buy, sell or hold a security. Please see the disclosures at the end of the publication, which are an important part of this article.