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, Principal, Senior Wealth Advisor & Co-President, Colony Sports & Entertainment

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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Shawn: Now you hear all kinds of deals about leasing cars, how can you negotiate a better deal if you want to lease?

Nina: Okay, well many people don't realize that they can actually negotiate the sticker price on a leased car in the same way that you would do that if you're buying a car. And since when you lease -- when you're, you know, your lease payments basically cover the depreciation, the difference between the sales price and the residual value. So it's definitely in your best interest to try to reduce that sales price as much as possible because then you'll pay you know, smaller dollars over the life of the lease. Make sure you pay attention to the down payment at the lease signing. And so here's an example, you might see an ad that says you know, lease payment is only 1.99 a month and that sounds like a great deal for thirty six months. The catch is, is that it might require a $3,600 down payment. So, if you amortize the down payment, then actually that 1.99 special, becomes 2.99. So, you really have to kind of look at total costs. 

And then lastly, dealerships use the term, money or lease factor, when they're calculating your financing costs and a lease factor is not the same as an interest rate. So, you have to make sure the dealer converts that lease factor into a comparable interest rate so you know what your financing charges are. 

Shawn: At the end of the day, does one method wind up being more expensive more often than the other, or can we tell that?

Nina: You know what, it really depends on how long, if you're going to hold the car for a long time, you're better off buying. But if you know, and if you're not, if you just really enjoy driving and you want to have a new car, then go ahead and lease. I mean, there's pros and cons to both, to be honest with you, it's not one size fits all.

Shawn: Alright Nina, great. Happy Thanksgiving to you. Alright, Nina Mitchell is with The Colony Group, for more go to wtop.com and search Her Wealth.

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Nina Mitchell, Principal, Senior Wealth Advisor & Co-President, Colony Sports & Entertainment

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, Colony's initiative to empower women with financial knowledge, resources and confidence.