Shielding Your Children’s Inheritance in the Event of a Divorce
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How smart estate planning can protect your family’s legacy for generations to come |
While many parents consider how to provide for their children through gifts or an inheritance, they may overlook a critical issue: how to protect that inheritance in the event of the child’s divorce. Estate planning offers tools to safeguard assets and ensure they remain within the family, even if a child faces the challenges of divorce.
The Impact of Divorce on Inheritance
In Maryland, inheritances are typically considered separate property, meaning they are not subject to division in divorce proceedings unless certain circumstances arise. If your child co-mingles inherited assets with marital property, for example, by placing the inheritance into a joint account or using it to purchase a home with a spouse, those assets may be at risk. Additionally, some divorcing spouses may argue that inherited funds were used for the benefit of the marriage, opening the door to disputes over ownership of those inherited funds.
This is why proactive estate planning is essential. You want to ensure that your children receive and maintain full control of their inheritance, regardless of any marital issues that may arise later.
Tools for Protecting Inheritances
There are several estate planning tools you can use to protect your children’s inheritance from the potential risks of a divorce:
1. Trusts
A trust is one of the most effective tools for ensuring that inherited assets remain separate and protected. By placing assets in a trust, you can provide for your children while shielding those assets from claims during a divorce. In a typical scenario, a parent establishes a trust for the benefit of a child, allowing the trustee (be it a third party or the child themselves) to manage the assets.
To maximize protection, the trust can be structured as a discretionary trust, where the trustee has complete discretion over distributions. This type of trust can ensure that assets are not considered marital property in the event of a divorce. Another option is a spendthrift trust, which prevents creditors, including a divorcing spouse, from accessing the trust assets.
These divorce protection trusts do not need to be created while the parents are living. Rather, it is common for these types of trusts to be created and governed by provisions in the will or revocable trust of the surviving parent. For example, suppose Husband and Wife have one Child who is 40 years old and married. Husband dies first, and at Husband’s death all of Husband’s assets pass to Wife. Upon Wife’s death, Wife’s will (or revocable trust) can provide that, instead of Wife’s assets being distributed outright to Child, Wife’s assets shall be held in a trust for the benefit of Child. The provisions creating the trust and governing the trust will be included in Wife’s will/revocable trust, so there is no need for a separate document creating the Child’s trust. Depending upon how the trust is structured, Child may even be able to serve as the sole trustee of such Child’s trust, thus providing Child with full control over his/her trust and avoiding costly trustee fees.
2. Prenuptial or Postnuptial Agreements
Encouraging your children to consider prenuptial or postnuptial agreements is another way to safeguard their inheritance. These agreements allow couples to outline how property, including inheritances, will be divided in the event of a divorce. While estate planning can shield assets, a prenuptial agreement offers additional clarity and can prevent legal disputes.
If your child is already married, a postnuptial agreement can still be executed to address inheritance issues. It is a smart complement to any estate planning efforts, as it can provide clear legal protection for inherited assets.
That being said, if children receive their inheritances from their parents in trust, rather than outright, the necessity of a prenuptial or postnuptial agreement with respect to protecting a child’s inheritance becomes less crucial.
3. Beneficiary Designations and Ownership Titles
Another way to ensure protection is through careful attention to beneficiary designations and ownership titles. In many cases, assets like life insurance, retirement accounts and payable-on-death accounts pass outside of probate. In other words, the disposition of these types of assets are not governed by wills. Rather, the disposition of these types of assets are governed by beneficiary designations (effectuated by signing hard copy beneficiary designation forms or by online designations). These designations must be kept up to date to ensure that the correct heirs inherit the property and that assets remain separate from a marital estate. For example, if parents, in their wills/revocable trusts provide for their children to receive their inheritance in trust, rather than outright, then beneficiary designations for such life insurance/retirement accounts/payable on death accounts may have to be updated to designate the trusts created for the children under their parents’ wills/revocable trusts.
It is also important to consider the implications of joint ownership of inherited property with a spouse. Joint ownership of inherited property can inadvertently co-mingle assets and open the door to claims in a divorce. Keeping inherited assets in an individual account under only the child’s name can help preserve the assets’ separate status. However, inherited assets titled in a child’s name (rather than a trust) may expose such assets to a child’s creditors. For this reason, inherited assets left in a trust for a child generally provides the most effective protection against a divorce or any other creditor of a child.
4. Gifting Strategies
Gifting can also be part of a larger estate planning strategy to protect assets. If you make outright gifts to your children during your lifetime, be mindful of how they use those assets. It is advisable to have conversations with your children about keeping inherited or gifted assets separate from marital property.
However, gifting assets in a trust (which would be created during the parents’ lifetimes, rather than under their wills/revocable trusts), instead of making outright gifts, can offer a greater level of protection.
Planning for Future Generations
While your primary concern may be protecting your child’s inheritance, it is important to also think about future generations. A well-designed estate plan can ensure that not only your children, but also your grandchildren and beyond, benefit from your assets. One way to achieve this is through a dynasty trust, which provides that after a child’s death, assets remaining in a child’s trust may divide into equal shares for such child’s children and continue in separate trusts for those grandchildren. In addition to protecting your children’s and grandchildren’s inheritance from divorce, a dynasty trust may also help avoid estate taxes and ensure that your wealth is preserved for multiple generations.
Reviewing and Updating Your Estate Plan
Estate planning is not a “set it and forget it” endeavor. Laws change, family circumstances evolve, and it is important to regularly review and update
your estate plan to reflect these changes. If your child gets married or divorced, or if there are changes in tax laws or state inheritance laws, your estate plan may need to be adjusted.
We urge you to work with a knowledgeable attorney to review your plan periodically and ensure that your assets are fully protected. In the case of divorce, timing can be critical, and early planning can prevent future legal battles.
Conclusion
Protecting your children’s inheritance from the potential complications of divorce is an important aspect of estate planning. Trusts, prenuptial agreements, careful asset titling, and gifting strategies all play a role in ensuring that your hard-earned wealth remains in the family for generations. By working with an experienced estate planning attorney, you can create a comprehensive plan that shields your assets and provides you and your children with security and peace of mind.
If you would like to speak with one of our estate planning attorneys, please contact Todd J. Bornstein at tbornstein@sgrwlaw.com.