Why would someone who is entering into a loving relationship want to plan for its failure?
The fact of the matter is we plan for things we don't want to occur all the time. We buy life insurance to protect us in the event of death. We buy disability insurance to protect us against a disability. We have auto and homeowner's insurance. We hope we never need this insurance protection, but we get it just in case, because we know bad things do happen.
The sad truth is that some marriages will not last. Statistically speaking, I've read that 1 out of 3 first marriages end in divorce. The statistics are even less favorable for second marriages. With these odds, planning for the possibility of a divorce probably makes more sense than buying some types of insurance ... it's just not that romantic.
The purpose of this issue of e-Counsel is to educate you on prenuptial agreements. As always, this issue of e-Counsel is only intended to be an overview of the topic under discussion and is not intended to give specific advice regarding any person's particular situation. If you have any questions regarding this e-newsletter, please do not hesitate to contact us.
What is a Prenuptial Agreement?
A prenuptial agreement is a written contract created by two people before they are married. Normally, prenuptial agreements specify what each person's legal and financial rights and obligations will be during the marriage and if (or when) the marriage ends, whether by divorce or death. Who gets the house? How are assets divided? Will there be alimony or maintenance, and if so how much? A prenuptial agreement can address and resolve these and other issues before a marriage even begins in a manner that is specifically tailored (or negotiated) to the couple's needs, wants and/or desires.
Prenuptial agreements go by many different names. Sometimes they are called "antenuptial agreements," "premarital agreement," or simply, a "prenup." No matter what they are called, however, they always refer to an agreement relating to marriage that is signed by two people before they are married. If such an agreement is made after a marriage, it is known as a "postnuptial agreement" or "postmarital agreement."
What Happens if You Do Not Have a Prenuptial Agreement?
In the context of estate planning, if a person dies without a will or other type of estate planning document such as a revocable trust, state law determines how a person's property is left. The state, in effect, drafts a will for a deceased person based on what the state feels is the best way for its citizens to leave property in the absence of that person specifically stating his or her intent. If you want to read more on what happens if a person dies without an estate plan, you can click here for our archived newsletter on this topic.
By analogy, getting married without a prenup is similar to dying without an estate plan. In other words, one way to look at marriage and prenuptial agreements is that whenever a couple gets married, they already have a certain type of "premarital agreement." This "agreement" is known as "divorce law" or other laws that generally affect a marital relationship.
Some people, however, may be unhappy with the way divorce law works, the uncertainty involved, or the amount of property they are required to leave to a spouse. Typically, but not always, these people have been through a divorce before. These people may now want to take more control of their lives, rather than leave it in the hands of the courts and government in the event a marriage is not successful.
Without a prenuptial agreement, if a couple were to divorce, a court decides all issues surrounding the dissolution of the marriage. These issues can include how a couple's marital property will be divided (which could include a business that one spouse may own) and whether one spouse will be required to pay maintenance or alimony to the other, and if so, how much.
Further, when people marry they are required to leave property to their surviving spouse at death. If they do not leave their spouse the required value of property, the surviving spouse will have a claim to the deceased's property in an amount equal to what the law allows. For example, in Missouri, a surviving spouse is entitled to get 1/2 of the estate if the decedent had no surviving descendants (children) or 1/3 of the estate if the decedent had surviving descendants. This may or may not be what a person wants. There are no hard and fast rules as to what a couple may want, especially when second marriages are involved or there are children from prior relationships.
Helen was married previously and has four children by a prior marriage. The prior marriage ended because her spouse died. Upon his death, Helen received $600,000 (mostly insurance). Two of the four kids are entering college and the other two will go to college in a few years. The insurance was designed to provide for the kids college in the event of a premature death. If Helen gets married and does not have a prenup, her new spouse would have a claim to $200,000 (1/3 of the $600,000). This would leave only $100,000 for each of Helen's children as opposed to $150,000 which may or may not be enough for each child's college education.
What is Typically Included in a Prenuptial Agreement?
For couples who do not want to rely on state law to decide what happens, a prenup can specify each spouses' financial rights and obligations. In general, prenuptial agreements typically address three broad areas:
- Property rights upon the death of a spouse;
- Property rights upon divorce; and
- Support rights upon divorce.
In addition, prenuptial agreements may also address other issues, including:
- Allocation of responsibility for payment of household and common expenses during the marriage;
- The right to control property during the marriage and to transfer or otherwise deal in property without the other spouse's consent; and
- Tax matters such as filing income and gift tax returns.
As a matter of law and public policy, there are things which a prenuptial agreement cannot cover. For example, a prenup is not binding and cannot resolve issues relating to child custody, child support or visitation rights. In addition, a prenup (like all contracts) cannot do or provide for anything that is illegal. A prenup also cannot be unconscionable (unfair) and cannot encourage divorce.
Lets delve a little deeper into the areas which prenups typically address.
Property Rights Upon the Death of a Spouse. As discussed above, a surviving spouse has rights to their deceased spouse's property. A prenup can be used to modify these rights which are otherwise granted under state law. For example, parties may wish to provide for a complete waiver of all rights to share in each other's estate at death. This means each party will retain what is his or her's and neither will have a right to any property owned by the other at death.
Other parties who enter into a prenup may want to make specific provisions for the surviving spouse. There are a variety of possible approaches someone can use, including:
- Creation of specified property rights during the marriage, such as a requirement that certain property will be titled in the name of or pass on death to one spouse;
- Requiring a party to make specified provisions in his or her will or other estate planning instrument, to take effect upon death, whereby certain property will pass to the surviving spouse;
- Requiring a party to leave a specified percentage of his or her estate to the surviving spouse.
By way of example, a prenup can be drafted so that upon one spouse's death, the couple's primary residence will be owned by the survivor (or the survivor will have the right to live in the residence for the survivor's life or a designated period of time). This can create certainty with the survivor knowing that he or she will have a place to live if one of them dies.
A prenup can also require a spouse to leave the survivor other property or a specific percentage of the estate, which could be paid outright or held in a trust for the survivor's benefit, depending on what the couple desires. Tax consequences should obviously be considered when structuring property distributions which will be left at death. Oftentimes, a spouse obtains a life insurance policy, the proceeds of which are intended to satisfy a payment obligation at death.
Of course, a party can always be more "generous" to their spouse if he or she desires, they are just not legally obligated to do so. For someone who has a prenup, but wants to leave more property to their spouse then the prenup provides, they have a number of options, including transferring separately titled property into joint names or into the sole name of the spouse, making a will or creating a trust for the benefit of the spouse, naming the spouse under beneficiary designations (for life insurance or retirement plan assets), or naming the spouse as a "pay on death" or "transfer on death" designee.
Property Rights Upon Divorce. In the absence of a prenup, property is generally disposed of in the event of a divorce by first determining what property constitutes marital property and what property constitutes the separate property of each spouse.
Separate property is generally defined as property acquired prior to the marriage, property acquired during the marriage through inheritance or gift, and property acquired in exchange for or which is traceable to any of these sources.
Generally, all other property acquired during the marriage is marital property, regardless of how that property is titled and regardless of which spouse's efforts produced that property. Marital property can also include property which a spouse is unable to prove is his or her separate property - usually because property was commingled with other property after the marriage.
After the property is divided between marital and separate property, a court divides the marital property between the spouses in a manner it deems just and reasonable. Separate property is not divided and stays with the spouse who owns that property.
A prenup can be used to clarify each spouse's property rights in the event of a divorce. For example, for a couple who wishes to have an agreement which is relatively clear, they can have a prenup that states that all property rights are determined by how property is titled. That is, all separate property titled in the name of one spouse will belong to that spouse. Property owned jointly will be marital property with each party having an equal ownership interest in the marital property regardless of their monetary contributions. Under this prenup format, you do not need to worry as much about commingling assets. The person whose name the property is titled in is the owner of the property.
Where the parties wish to maintain separate property, but also provide for the less wealthier spouse, there are a variety of options that can be considered, including:
- The wealthier spouse agrees to pay for a marital home which will be jointly titled;
- The parties agree that their salaries will be deposited into a joint account and all acquisitions made from that account will be jointly owned;
- The wealthier spouse agrees to make annual gifts to the other spouse;
- The wealthier spouse agrees to pay for living expenses allowing the less wealthy spouse to accumulate separate property;
- The wealthier spouse agrees to transfer certain property to the other spouse;
- The less wealthy spouse will receive a specified sum of money upon divorce which may be tied to the length of the marriage.
Support Rights Upon Divorce. Prenups can take a variety of approaches to the subject of spousal support according to the objectives and circumstances of the parties.
For example, a prenup may be silent on the subject of spousal support or may specifically state that spousal support is to be determined if a divorce occurs. If this is the case, a court will have authority to make a spousal support award, if appropriate, under the same circumstances and using the same criteria it would use in the absence of a prenup.
Alternatively, a prenup can provide for a complete waiver of spousal support. This would mean that if a couple divorces, a spouse would not be entitled to receive any form of support such as temporary or permanent maintenance or alimony.
The middle ground is a prenup that provides for a predetermined amount or percentage of income to be paid to a spouse in the event of a divorce. The amount can be paid for an indefinite period of time or it can be paid for a certain period of time. Often, the amount or percentage is tied to the length of the marriage (a higher support obligation the longer the marriage lasts).
Who Might Want to Consider a Prenuptial Agreement?
Contrary to popular opinion, prenups are not just for the rich. While prenups are often used to protect assets, couples of more modest means are increasingly turning to them. Even a person who has managed to save $100,000 may be protective of his or her nest egg because it has taken a lot of hard work to accumulate.
With that said, we have seen the following categories of people consider prenuptial agreements:
- A person has assets such as a home, stocks or retirement funds that he or she wants to protect;
- A person owns all or part of a business that he or she wants to protect;
- A person has or expects an income stream for salary or business distributions he or she wants to protect;
- A person expects to receive an inheritance that he or she wants to protect;
- A person has children from a prior marriage that he or she wants to financially protect;
- A person has other loved ones (such as parents) that he or she wants to financially protect;
- A future partner has a high debt load;
- A person is in a much weaker financial position then their future partner and wants certainty as to what will happen in the event of divorce or death.
Prenups are often used with second marriages. In these cases, a prenup can be effective to pass separate property to children from prior marriages. A marrying couple with children from prior marriages may use a prenup to spell out what will happen to their property when they die, so that they can pass on separate property to their children and still provide for each other. As previously noted, without a prenup, a surviving spouse might have the right to claim a large portion of the other spouse's property, leaving much less for the kids.
Even couples without children, wealthy or not, may simply want to clarify their financial rights and responsibilities during marriage and avoid potential arguments if they ever should divorce by specifying in advance how their property will be divided, and whether or not either spouse will receive maintenance or alimony.
Are Prenuptial Agreements Valid and Enforceable?
As prenuptial agreements become more common, the law is becoming friendlier toward them. Traditionally, courts scrutinized prenups with a suspicious eye, because they almost always involved a waiver of legal and financial benefits by a less wealthy spouse and they were thought to encourage breakups. As divorce and remarriage has become more prevalent, and with more equality between the sexes, courts and legislatures are increasingly willing to uphold premarital agreements. Today, every state permits them, although a prenup that is judged unfair or otherwise fails to meet state requirements can be set aside.
In order to be valid and enforceable, a prenuptial agreement should at least meet certain requirements. Both parties should be represented by separate lawyers. Further, each party should fully disclose his or her financial situation and assets to the other party. This disclosure should be in writing and attached to the prenup.
How to Approach the Topic of a Prenuptial Agreement With a Potential Future Spouse?
If you decide you want a prenup, the next and possibly the most difficult step is to speak to your partner. This can be a daunting task. However, if it is approached properly, it does not have to be a relationship deal-breaker.
Believe it or not, the process of getting a prenup can be positive in the long term. It guarantees that each person is heard, listened to, and supported. There might be anger or frustration along the way, but the process also offers a perfect opportunity to discuss each other's needs, wants, and fears. Put another way, if two people are unable to sit down and talk rationally about their needs and fears when the relationship is good, then how bad might it be if things ever turn sour?
This is not to say that there will not be stressful times. There will. However, if you start with and accept the premise that each party wants to get married and wants the marriage to last, things will be a little easier.
Always be honest and up front when discussing a prenup with a future spouse. Tell them why it is important to you, whatever those reasons might be. Explain that a prenup can create certainty in terms of what will happen for both of you if one of you dies or there is a divorce. Certainty goes both ways. What is the benefit of your future spouse signing a prenup? Will they get the house? Is there insurance to provide for them? Often a person is uncomfortable with a prenup because of the unknown.
Listen to what your future spouse has to say. If they have fears, do not simply dismiss them. Those fears are real, and you need to work through them together. Try to put yourself in your future spouse's shoes. How would you feel?
Finally, and perhaps most importantly, never wait to the last minute before talking about a prenup. It is probably human nature to put off topics that can cause tension, but this will not go away by ignoring it. If anything, the situation will get worse. Negotiating or signing a prenup that is close to the wedding date is a recipe for disaster.
We trust you have found this issue of e-Counsel to be interesting and informative. If you have any questions regarding anything contained in this issue or if you have any ideas as to how we can improve our newsletter, please do not hesitate to contact us.
CIRCULAR 230 DISCLOSURE
Under U.S. Treasury Department guidelines, we are required to inform you that (1) any tax advice contained in this communication is not intended or written to be used, and cannot be used by you, for the purpose of avoiding penalties that may be imposed on you by the Internal Revenue Service, or by any party to market or promote any transaction or matter addressed herein without the express and written consent of the Richard C. Petrofsky Law Office and Helfrey, Neiers & Jones, P.C., (2) the Richard C. Petrofsky Law Office and Helfrey, Neiers & Jones, P.C. imposes no limitation on any recipient of this tax advice on the disclosure of the tax treatment or tax strategies or tax structuring described herein, and (3) any fees otherwise payable to the Richard C. Petrofsky Law Office or Helfrey, Neiers & Jones, P.C. in connection with this written tax advice are not refundable or contingent on your realization of federal tax benefits from the advice contained herein.