Affluent families have long been concerned about how best to protect inheritance from divorcing spouses and other creditors, and it's likely that this age-old concern will only increase.
The U.S. is in the midst of the largest intergenerational transfer of wealth in history, estimated to reach $59 trillion by 2061, as members of the baby boom generation die and transfer property to surviving spouses and then to children, according to the Boston College Center on Wealth and Philanthropy.
As a general rule, property that someone receives as a gift or a bequest is not considered to be marital property that would be subject to division in the event of divorce, even if the recipient is married at the time she or he receives the gift or bequest. However, the protection of the general rule may be lost if the property received as a gift or bequest is commingled with other property that is considered to be marital.
In that instance, a judge presiding over a subsequent divorce might very well infer an intent on the part of the spouse who received the gift or bequest to make such property marital property as a result of the commingling. And the judge could then divide such property between the divorcing parties, and the protection of the general rule would be lost.
Keep property separate
For this reason, many advisers will suggest that property received as a gift or bequest be kept in a separate account that is titled in just the recipient's name. Many parents will encourage a child to create such an account to hold an intended gift or bequest, in an effort to prevent commingling and to keep the transferred property separate in the event of a divorce.
While the use of a separate property account provides some measure of protection, it does not offer the greatest protection. That's because, given that the separate property account is in the recipient's name, typically she or he will have unfettered control over it, and thus can make withdrawals from the account, which then can become commingled. In addition, because the owner of the separate property account typically has unfettered access to the account, that person's general creditors can attach a lien to the account.
Parents who seek greater protection for the property they gift to children while they are alive or after their death are well advised to make such gift or bequest in trust for their child. Generally, a properly structured trust will protect the gift or inheritance from all creditors, and a divorcing spouse. If properly structured, a trust will provide more protection than a separate property account.
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In fact, a properly structured trust can be even more protective than a pre- or post-nuptial agreement, as well. It also avoids the need to fully disclose one's assets and net worth, which generally is required in order for the pre- or post-nuptial agreement to be enforceable.
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And whereas the burden of obtaining such an agreement is typically on the child's shoulders, often at a very sensitive time in the child's relationship with the spouse-to-be, the creation of a trust is a burden the parents can shoulder. Moreover, it enables the child to place the onus on parents: the child is able to say, "Look, Darling, I trust you implicitly and know our marriage will last. But my parents are very conservative about these matters and they created the trust. There's nothing I can do about it."
Glenn Kurlander is a managing director and head of family governance and wealth education for Morgan Stanley Wealth Management.