Prenuptial and Estate Plans ? Make Sure They Work together
If you are getting married, estate planning is probably the last thing you want to think about. But if you and your future spouse plan to sign a prenuptial agreement (commonly referred to as simply a "prenup"), it is a good idea to design the agreement with your estate plan in mind. A well-planned prenup can provide several estate planning benefits; a poorly planned one can trigger unintended tax consequences or hinder achievement of your estate planning goals.
Estate Planning Benefits
Prenups are usually associated with divorce. But they also provide several benefits for successful marriages, including protection from liability for your spouse's separate debts and implementation of estate planning strategies.
Giving a Surviving Spouse Rights
Most estates give a surviving spouse certain rights to a deceased spouse's property. In community property states, for example, a surviving spouse enjoys a 50% interest in all community property. In most other states, surviving spouses can choose to receive an "elective share" amount ? usually between one-third and one-half of the deceased spouse's estate.
These rights supersede the terms of a will, but they can be waived in a prenup, which does not necessarily mean that you will be disinheriting your spouse. Prenups typically preserve a spouse's right to receive a substantial portion of the other spouse's wealth. But by waiving marital property rights, they allow you to specify the manner in which your assets will be distributed and ensure that your estate plan will operate as intended.
How Estate Planning Can Protect Children from a Previous Marriage
Suppose, for example, that you own a closely held business that you run with your children from a previous marriage. Assume further that the business makes up 75% of your net worth and you want your children to inherit it. A prenup can prevent your spouse from acquiring an interest in the business ? either through a divorce or spousal inheritance rights ? while preserving his or her right to the other 25% of your estate.
Estate Planning Traps
A prenup should work in concert with your estate plan, rather than against it. Here are a few areas where traps may lurk:
For an agreement to be legally enforceable, each party must provide "adequate consideration" ? that is, the parties must exchange items or promises of comparable value to create a binding contract. Typically, prenups transfer property rights from one spouse to the other in exchange for the release of certain marital rights. If the transfer takes place before marriage, however, it can trigger income and gift taxes.
The best strategy is to make the transfer after the wedding, because transfers between spouses generally are exempt from both income and gift taxes. There are exceptions, however, when a non-U.S. citizen spouse is involved.
The Estate Tax Exemption
For couples with larger estates, an important goal of estate planning is to maximize the use of each spouse's estate tax exemption ($5.12 million for 2012 but, as of this writing, scheduled to drop to $1 million for 2013 and beyond). Often, this is accomplished by placing assets up to the exemption amount in a credit shelter trust, with the excess distributed to the surviving spouse (either outright or in a marital trust).
If a prenup distributes too much to the surviving spouse, it can leave the credit shelter trust underfunded, triggering unnecessary estate taxes in the surviving spouse's estate. A prenup should have the flexibility to accommodate this estate planning strategy and adapt to future changes in the exemption amount.
The Disposition of the Family Home
Prenups often provide for the sale or other disposition of the family home, or give the surviving spouse the right to continue living there. The prenup should be drafted so that it does not impede your ability to execute home-related estate planning strategies, such as transferring the home to a qualified personal residence trust.
Prenups offer several significant financial and estate planning benefits. To maximize these benefits and avoid tax traps, work with your advisor to ensure that your prenup operates in harmony with your estate plan.