Death and taxes are life’s only certainties, but getting divorced - or having an heir who gets divorced - is getting pretty close to a sure thing. Here are some tips for keeping the divorce lawyers away from your life savings and your children’s inheritance.
Divorce. No one likes to talk about it; even fewer actually plan for it. But as authors and advisers to physicians on legal and financial planning, we can tell you that the breakup of a marriage is second only to taxes as a threat to a physician’s financial security.
More than half of all marriages in this country end in divorce - and for second marriages, the divorce rate is closer to 75 percent. As emotionally devastating as a divorce is personally, it can be financially disastrous, too.
So the smart thing to do is to plan for divorce. Yet divorce planning is not about hiding assets from a soon-to-be ex-spouse, or cheating or lying to keep your wealth. Rather, it’s about resolving property issues before things go sour. By agreeing upfront what will be yours and what will be your spouse’s, you can save money, time, and stress in the long run. In fact, this type of asset-protection planning inevitably benefits all parties - except the divorce lawyers, of course.
Divorce planning is also about shielding family assets from the potential ex-spouses of children and grandchildren. With divorce rates so high, it’s a near-certainty that a child or grandchild of yours will get divorced. Thus, for intergenerational wealth-protection planning, this is a crucial topic, unless you want to give half your inheritance to the ex-spouses of your heirs. As you will learn, there are ways to protect your children and grandchildren without having to persuade their spouses to sign a prenuptial agreement.
Can a prenup protect you?
A premarital agreement (or prenuptial agreement, premarital contract, post-nuptial agreement, etc.) is the foundation of any protection against a divorce involving you. The premarital agreement is a written contract between the intended spouses. It specifies the division of property and income upon divorce, including disposition of specific personal property, such as family heirlooms. These agreements may also lay out responsibilities during marriage, such as what each spouse can expect in financial support or in which religion future children will be raised. The agreement cannot limit child support.
Protecting income in a prenup is more challenging than protecting assets accumulated before marriage. Typically, we recommend that a physician shield income from potential creditors through a tax-beneficial nonqualified deferred compensation (NQDC) plan or nontraditional executive benefit plan. Such plans normally will also reduce the physician’s taxable income (for future benefit), thereby reducing the income value for divorce purposes. Unfortunately, few physicians implement such plans, usually because they have not been advised about their benefits.
If you have not yet implemented a pre- or post-marital agreement, an irrevocable trust can be a useful tool. Irrevocable trusts are effective asset-protection tools because you no longer own the assets controlled by the trust. You have transferred the property with no strings attached. Because you neither own nor control the property, your creditors, including an ex-spouse, cannot claim the assets.
Using trusts to protect your kids
When your children or grandchildren come to you, giddy with exciting news about their recent engagements, the last thing they want to hear you ask is “Are you going to sign a prenuptial agreement?” In fact, if you weren’t paying for the wedding, you might lose your invitation just for asking.
So what can you do to shield family assets from a child’s divorce? Often, an irrevocable trust is the answer.
You can make children, grandchildren, and even future great-grandchildren beneficiaries of an irrevocable trust. However, the trust can be drafted so that the beneficiaries’ creditors, including divorcing ex-spouses, cannot reach the trust assets. To do so, these trusts have special “spendthrift” provisions.
By leaving assets to your children’s irrevocable trusts - rather than to your children personally - you can achieve this goal. Of course, if the children take money out of the trust and use it to buy a home or other property while married, that property will be subject to the rules in each state. Let’s look at an example:
Rob and Janelle got married right out of college. Their marriage turned sour within a few years, and they began divorce proceedings. However, during their three-year marriage, Janelle received a large inheritance and used it to pay off the couple’s home. When the two filed for divorce, Rob’s attorney successfully argued that his time and labor on the house and the fact that he lived in it made half of the equity in the home, about $100,000, Rob’s fair share. Janelle’s grandparents certainly didn’t intend for Rob to receive their inheritance.
What could Janelle have done? Her grandparents could have left her the inheritance through an irrevocable trust that allowed her to take out only so much per year. In that case, she could have used the interest from the inheritance to pay the mortgage down each month, while the body of the inheritance would have remained separate property and would not have been part of the divorce settlement. The couple would not have been able to pay off the mortgage in its entirety. Thus, they would have had very little equity in their home at the time of their divorce; Rob would have left the marriage with little more than what he brought into it, and Janelle would still have her grandparents’ trust.
We’re not arguing that this arrangement is fair or unfair; we aren’t marriage counselors. We are only trying to help you reach your desired financial objectives.
A little planning can go a long way to making sure that a divorce doesn’t completely disrupt a family’s financial situation.
David B. Mandell, JD, MBA, is an attorney, lecturer, and author of “Wealth Protection, MD.” He is also a cofounder of the Wealth Protection Alliance (WPA), a nationwide network of independent financial advisory firms whose goal is to help clients build and preserve their wealth. Christopher P. Jordan is the president and chief executive officer of LEXCO Wealth Management Inc. and provides sophisticated business planning to physicians around the country. Mandell and Jordan can be reached at 800 554 7233 or via email@example.com.
This article originally appeared in the July/August 2006 issue of Physicians Practice.