Marriage, Money, and Peace of Mind: The Power of Premarital Planning

The Importance of Premarital Planning

Planning a wedding is an exciting time filled with much joy and anticipation.  Amidst the celebrations, it is easy to overlook the less romantic side of marriage; that is, the legal and financial partnership that ensues after saying “I do.”  Many couples do not decide how they will manage their assets and finances after the wedding.  Fewer understand the consequences, favorable or unfavorable, of merging their separate property.  Whether you are getting married for the first time or remarrying later in life, it is essential to understand the impact marriage may have on your assets, and how thoughtful planning can protect them.

Premarital planning has always been relevant among high-net worth individuals and others who stand to inherit significant family wealth.  In recent years, such planning has become more mainstream as divorce rates remain high in the U.S.  Still, some associate premarital agreements with distrust, divorce, and, overall, as a poor way to start a happy marriage.  In addition, some resent or resist premarital agreements that include “behavior clauses,” such as prohibiting smoking or an attempt to impose harsh financial consequences if there is infidelity during the marriage.  While the topic of premarital agreements may be awkward for an engaged couple, the process can be a positive experience, providing the couple with an opportunity for financial transparency, open communication, and a sense of security for both parties.

The reality is that, apart from annulment, there are only two ways a marriage ends: divorce or death.  Accordingly, premarital planning often coincides with estate planning.  It is important that a couple explore together the difficult discussions regarding what will ensue financially in the event of death or divorce.  Even if the parties decide not to proceed with a premarital agreement, the process can provide each with a clear understanding of their rights and financial situations regardless of the marital outcome.

Understanding Premarital Agreements

A premarital agreement is a legal contract entered into by two people before they marry.  It outlines how each party’s assets, debts, and financial responsibilities will be handled during the marriage and in the event of divorce or death.  It can also specify what if any maintenance or alimony payments a spouse will receive if there is a divorce.  Often, parties refer to a “premarital agreement” as a “prenuptial agreement” — or a “prenup” for short.  Whatever one calls the agreement, in addition to financial matters, a premarital agreement can also address the parties’ intent regarding the care and custody of any minor children; although, such provisions are not binding on a court.  For example, through a premarital agreement in several states, parties may not agree to absolve a party of child support and child education responsibilities.

Before explaining the mechanics of a premarital agreement, it is important to understand how property can be divided upon divorce without a premarital agreement.  How an asset is divided in that instance depends upon whether it is considered “separate” or “marital” property.  Marital property is generally any property the married couple earns or acquires during the marriage.  This can include the marital residence, other real estate acquired during the marriage, income earned during the marriage, and bank and investment accounts owned jointly.

Separate property generally refers to property owned by a party prior to the marriage, including business interests, real estate, bank accounts, and investment accounts, as well as income or appreciation derived from those assets.  It may also include a spouse’s inheritance and gifts, even if they are received during the marriage.  Separate property belongs only to one spouse and remains that spouse’s property upon divorce.

Almost every state in the United States is either a “community property” or an “equitable distribution” state when it comes to divorce.  “Community property” states are those that treat most property acquired during marriage as jointly owned by both spouses.  When a couple divorces in a community property state, marital property is generally divided 50/50, regardless of who earned or purchased it (unless the parties have a valid agreement stating otherwise, such as a prenuptial or postnuptial agreement).

While almost 20% of states, such as California, Arizona, Nevada, and Wisconsin, are still considered “community property” states, most states observe what is called “equitable distribution” upon divorce.  In equitable distribution states, divorce courts will usually divide marital property based upon what is fair and equitable; however, fair and equitable does not necessarily mean equal.  Thus, instead of awarding one-half of the marital assets to each party, as typically occurs in a “community property” state, a court can and may award a party more than one-half of an asset or more than one-half of the marital assets if doing so is equitable under the circumstances.  In deciding what is equitable, a court may consider factors such as the length of the marriage, each spouse’s earning capacity, financial contribution to the marital assets, and future needs of the parties.  A court can also recharacterize separate property into marital property, which can then be subject to equitable division.  Without a premarital agreement, property division upon divorce is unpredictable, subject to court discretion, and may not feel equitable at all.

Instead of leaving it to a court to decide the fate of their assets, many couples utilize a premarital agreement to decide in advance how their property will be divided upon divorce.  This decision can even include division of tangible personal property such as art, jewelry, furniture, and collectibles, especially when those items have significant monetary or sentimental value.  A well-drafted premarital agreement will clearly define what constitutes each spouse’s separate property and which will not be divided in a divorce.  The premarital agreement will also address how marital property will be divided.  Usually, marital property will be divided equally between the parties, depending in part on other resources and income a party may have.  Significantly, a well prepared and fair premarital agreement can spare a divorcing couple from not only the angst of a bitter dispute but also unnecessary and expensive legal fees.

State law varies considerably regarding premarital agreements.  In most cases, a premarital agreement requires each party to be represented by separate and independent counsel.  Most states also require each party to provide full financial disclosures to the other, which includes disclosure of all assets, liabilities, and income.  Most states also look askance at unconscionable premarital agreements.  A premarital agreement should also be prepared and signed well in advance of the wedding.  If a premarital agreement is signed too close to the wedding date, for example, a few days prior, the risk of a successful challenge to the premarital agreement increases due to issues such as inadequate financial disclosures, insufficient time for negotiation, or claims of duress.

How Premarital Agreements Can Affect Estate Planning

Premarital agreements do not just protect you in divorce.  They are also important tools that can shape your estate plan.  In fact, your estate plan (including your will, trust, and beneficiary designations) should align with your premarital agreement.  For example, if your premarital agreement waives your spouse’s right to an elective share of your estate, your estate plan should clearly reflect that waiver.

Coordinating your premarital agreement with your estate plan is especially important if the spouses do not share the same testamentary intent.  For example, if the spouses each have children from prior relationships, they may not wish to provide for their spouse and instead only desire to provide for their respective children upon death.  While each spouse may prepare his or her estate plan to reflect these wishes and identify different beneficiaries, failure to address the separation of assets could result in an asset being divided equitably upon divorce.  This division could well frustrate the spouse’s intent to distribute those assets to their children.

Premarital agreements are especially useful when one spouse wishes to protect certain assets from equitable division.  Perhaps the most common example of such an asset is a family business.  If one spouse owns an interest in a family company, it is likely that spouse (and the spouse’s family) wants to protect that equity from transfers to a third-party upon divorce.  With a premarital agreement, the parties can clarify that the family business remains separate property.  From there, the estate plan can address how the family business interests will be distributed upon the death of the spouse.  If the goal is to ensure continued ownership within the family, the estate plan can provide that the business interests will only be distributed to descendants, siblings, or other family members who are active in the business.  Taken one step further, the estate plan and premarital agreement should also coordinate with the buyout provisions of any buy-sell, shareholder, partnership or operating agreement for the family entity.

Even if you enter a marriage without a premarital agreement, you still have options to protect your assets through estate planning.  Depending on state law, couples may be able to execute a postnuptial agreement to clarify their intent, even if they are already married.  Another option is to establish a self-settled domestic asset protection trust.  Under this type of trust, the spouse who established the trust will remain the sole beneficiary of any assets added to the trust during that spouse’s lifetime.  In many cases, establishing a self-settled domestic asset protection trust before marriage can ensure the assets the spouse contributes to the trust remain that spouse’s separate property during the marriage and in the event of divorce, even without a premarital agreement.

Some Tips to Consider, With or Without a Premarital Agreement

While a premarital agreement will address how assets should be divided in divorce, actions during the marriage may impact how certain property is characterized.  For example, separate property may be converted to marital property if it is commingled with the other spouse’s assets or if both spouses have access to it.  Thus, a premarital agreement is only the first step in protecting separate assets.  Care must be taken to ensure separate property is not inadvertently converted into marital property.

Even without a premarital agreement, the tips below can help ensure separate property remains separate, and therefore safe from equitable division upon divorce:

1. Do Not Commingle: Refrain from combining assets into a common account with your spouse.
2. Do Not Add a Joint Owner: Do not add your spouse to your existing bank or brokerage accounts as a joint owner.
3. Do Not Provide Free Access to Assets: Allowing your spouse unlimited and unfettered access to your separate property can cause such property to be recharacterized as marital.
4. Be Mindful of Contributions: Separate property contributed towards the cost of the purchase of or improvements to a marital asset will almost invariably convert to marital property.  For example, equity in the marital home will be considered marital property, even if the spouses contributed separate funds to pay the mortgage.

Regardless of whether you choose to sign a premarital agreement, thoughtful planning today can prevent costly disputes tomorrow.  If you are considering a premarital agreement or want to review your estate plan before an upcoming marriage, we invite you to schedule a consultation.  Let’s make sure your future is protected the way you want it to unfold.

This publication is intended for general informational purposes only and does not constitute legal advice or a solicitation to provide legal services. The information in this publication is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this information without seeking professional legal counsel. The views and opinions expressed herein represent those of the individual author only and are not necessarily the views of Clark Hill PLC. Although we attempt to ensure that postings on our website are complete, accurate, and up to date, we assume no responsibility for their completeness, accuracy, or timeliness.