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Inheritance protection is critical as family dynamics become increasingly complicated and divorce rates hold steady. A marriage ending significantly increases the risk of dividing inherited assets, leading to costly and prolonged disputes. Financial advisors are essential in helping clients safeguard their legacies through careful planning and collaborating with legal experts.
Understanding Marital Risk and Inheritance Vulnerability
Although few marry intending to divorce, things happen, and some happy unions ultimately dissolve. According to the Census Bureau, divorce rates for women 15 and older were 7.1 per 1,000 people in 2022. In another survey, 15.2% of older adults divorced the same year, triple the 1990 levels.
Matters become even trickier when inheritances are enmeshed in divorce proceedings. When one party receives an inheritance, it could become marital property through joint or mixed ownership, also called community property. For example, funds are difficult to distinguish when the couple purchases a home using the inheritance.
Commingled property is when the inheritance is deposited into a joint bank account, accessible by both partners. They might use the account to pay bills or make joint purchases. Dividing the remaining amount is also challenging during a divorce.
Although numerous jurisdictions automatically consider inheritances separate property, clients must issue the proper protections to keep funds separate. Otherwise, it becomes marital risk.
Proactive Strategies for Inheritance Protection
Clients often turn to financial advisors for guidance regarding inheritance protection. These proactive strategies may be viable options for safeguarding individual assets.
Trust Structures
Discretionary and spendthrift trusts help clients protect inherited funds from property division. The first gives a sole disinterested trustee permission to determine when and how much of the inheritance to disperse to beneficiaries, giving the spouse limited amounts during a divorce.
Spendthrift trustees restrict the beneficiaries’ authority to transmit their interest, making it harder for creditors and former spouses to withdraw assets. You might also suggest adding a provision that excludes nonbeneficiaries from having legal rights in the trust. This means the trust is available to the beneficiaries, excluding an ex-spouse, in divorce proceedings.
Prenuptial and Postnuptial Agreements
Many couples prefer to avoid discussions about prenuptial and postnuptial agreements due to fears of distrust and relational harm. However, they can be a powerful tool for protecting a future inheritance from marital risk.
You should help your clients define separate assets, particularly how they intend to divide money in case of a divorce. They must enter these agreements voluntarily, maintaining complete financial transparency and seeking independent counsel. Otherwise, the contract is unenforceable without the full disclosure of finances or if it was signed under coercion or duress.
Gifting and Titling
To help your clients protect their future inheritance from marital risk, you should place the funds in individual accounts to avoid commingling with joint assets. Titling the amount in the inheritor’s name further solidifies the division.
The inheritor could give a direct monetary gift to their spouse with a check or money transfer, although not to their shared account. The giver should also write a letter indicating that the gift is for the recipient only.
Proper recordkeeping is crucial for all strategies related to gifting and titling, including documentation of the original inheritance, associated transactions and statements of intent. You might encourage them to retain digital files in a cloud system. However, security features like encryption and multifactor authentication are a must, considering 44% of people have been victims of a cloud data breach.
Ongoing Education and Communication
Providing your clients with resources and ongoing education regarding their inheritance will empower them to make the right legal and financial decisions. Have them communicate with their partner and family members with the utmost clarity and transparency, explaining the importance of keeping assets separate.
While these conversations may not always be easy, they are essential to preventing marital risk, fostering proactivity and avoiding misunderstandings and disputes later on.
Collaborating with Legal Professionals
Collaborating with legal professionals can further improve safeguards for clients. An interdisciplinary approach ensures all concerns are addressed appropriately before potential disputes.
For instance, you may work with an estate attorney to arrange a discretionary trust, guaranteeing that the inheritance will remain separate property in case of a divorce. The partnership delivers a holistic system to asset management and fosters a deeper advisor-client association.
Proactive Planning for Inheritance Protection
Clients can best protect their inheritance from marital risk through your guidance and careful approach to asset management. Encourage open, transparent communication and coordinate with legal experts, remaining alert and informed to give them peace of mind.
Related: Why Your Client’s Will Is Not Enough: An Advisor’s Guide to Modern Trust Planning