Although the divorce rate has fallen for many years, the emotional and financial costs from a split-up are often very high. Protecting inherited assets from a claim by a family member’s ex-spouse can help limit those losses. Such protection can be a cornerstone for sound estate planning.

Few terms have the potential to kill the excitement of a wedding engagement as quickly as “prenuptial agreement.”

Among other benefits, these agreements can ensure an inheritance does not go to a descendant’s ex-spouse by clarifying the holdings of a couple and how they would split their assets in the event of divorce or death. But a prenuptial agreement can also provoke stress for a young engaged couple who envision a future of marital bliss and resent any pressure to negotiate a contract that contemplates their divorce.

Protecting inheritances is an especially crucial part of multigenerational planning given the huge transfer of wealth to come. As baby boomers in North America pass away during the next four decades, they will give to their descendants about $30 trillion in inheritance, according to Accenture.

While we are advocates of prenuptial agreements and their ability to cover a broad range of issues, families may consider alternatives that focus on protecting a family legacy. A parent or grandparent can set up many of these vehicles without the consent of, or any financial disclosure to, a descendant’s future spouse. These approaches can last for generations and also shield family assets from general creditors.

Different Paths

Two alternatives, which can be set up long before any marital engagement, include:

Discretionary trust. This empowers an independent trustee to manage the trust assets and make decisions regarding distributions to descendant’s. If necessary, the trustee can distribute assets to a descendant. But the descendants’ lack of control over the assets ensures that ex-spouses and creditors cannot make a legitimate claim into the future. A discretionary trust can provide a means of multigenerational estate planning by establishing how assets are passed on and reduce future generations’ potential estate-tax liability.

Family limited partnership (FLP). This is a closely held business similar in structure to a limited liability company. A descendant can own an interest in an FLP but, as with a discretionary trust, a single party can manage FLP funds and make decisions regarding distributions from the partnership to family members. An FLP can ensure solid protection of its funds from claims by a descendant’s ex-spouses and creditors. FLPs also are excellent investment vehicles, enabling families to pool investment assets and streamline both management and oversight.

These structures avoid the possible complications and hurt feelings that can accompany a prenuptial agreement. Young couples in love may feel offended by pressure from family to enter into prenuptial agreements and, in the midst of their joy, may resist entering into an agreement that feels like a business transaction. Also, if only one family insists on a prenuptial agreement, it risks sending a message of mistrust. Pressure to enter into an agreement may provoke lasting resentment. Sometimes discussions over a prenuptial agreement become so contentious that the families abandon the idea altogether.

 

Shielding Assets

While offering meaningful advantages for estate planning, prenuptial agreements are not the only way to protect inherited assets against claims by former spouses. Two alternatives fulfill the same role, while also offering additional benefits.

 

Still, even after creating the above estate-planning vehicles to protect inheritances, some families may want their children and grandchildren to enter into prenuptial agreements. The agreements have the advantage of detailing how assets would be split in a divorce, whether inherited assets would be subject to division and the support obligations each spouse has to the other.

Stress Reduction

We have identified some ways that can limit the potential stress from drawing up a prenuptial agreement:

First, provide as much forewarning as possible. If a family plans to ask all children and grandchildren to sign an agreement, the family should raise the topic well before any potential spouses have entered the picture to show that the agreement is family practice and not disapproval of any individual or his or her fiancée. For the people entering into the family, the more time that they have to adjust to the idea of a prenuptial agreement and understand the family practice, the less likely they will feel under pressure.

Second, families can ask that a child’s or grandchild’s prenuptial agreement focus only on inherited assets while characterizing those assets as a legacy to preserve for future generations. At the same time, the engaged couple can have total discretion over how to handle the assets that they accumulate during the marriage.

Finally, families can reduce the chances for lasting resentment by making the discussion over the prenuptial agreement more like a negotiation instead of an imposition.

Ideally, every engaged couple will plot their own path to “happily ever after.” Prenuptial agreements— or alternatives like a discretionary trust or FLP—may not ensure marital bliss. But they can be essential to protecting a legacy.

 

Please download The Advisory to read other articles in this issue including:

Shadow Consumption
By Paul Chew, CFA, Head of Investments

Economic recoveries usually feature a surge in consumption as employment and wages rebound. Current U.S. consumption data might instead suggest that many consumers are on the sidelines. But rather than clutching their pocketbooks, consumers are reaching for their smartphones and using digital technology to find bargains online and to share goods, potentially influencing the data.

Europe's Slow Climb
By Mick Dillon, CFA, Portfolio Manager, Global Leaders Strategy; Priyanka Agnihotri, Equity Research Analyst

Greece’s debt crisis has dominated the headlines in Europe this year but has not halted regional growth or vitality among European companies showing unexpected earnings strength.

Rude Awakening
By Stephen Shutz, CFA, Tax-Exempt Portfolio Manager

As recently as 2012 Puerto Rico was able to sell to investors public-sector bonds despite its bleak fiscal outlook and shrinking economy. The commonwealth’s default last month on a portion of $72 billion in troubled debt spotlights not just an ill-advised investment, but a pitfall in the municipal bond market.

Dream or Opportunity
By Taylor Graff, CFA, Asset Allocation Analyst

China’s plummeting stock prices, slowing economic growth and currency volatility have pushed many investors out of the market. Nevertheless, we believe that a discriminating investment strategy toward China and neighboring emerging markets has the potential to yield meaningful long-term gains, especially from growth in China’s middle class.

The views expressed are those of the authors and Brown Advisory as of the date referenced and are subject to change at any time based on market or other conditions. These views are not intended to be a forecast of future events or a guarantee of future results. Past performance is not a guarantee of future performance. In addition, these views may not be relied upon as investment advice. The information provided in this material should not be considered a recommendation to buy or sell any of the securities mentioned. It should not be assumed that investments in such securities have been or will be profitable. To the extent specific securities are mentioned, they have been selected by the author on an objective basis to illustrate views expressed in the commentary and do not represent all of the securities purchased, sold or recommended for advisory clients or other clients. The information contained herein has been prepared from sources believed reliable but is not guaranteed by us as to its timeliness or accuracy, and is not a complete summary or statement of all available data. This piece is intended solely for our clients and prospective clients and is for informational purposes only. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Circular 230 Compliance Statement: Regulations contained in IRS Circular 230 regulate written communications from us concerning tax matters. In compliance with those regulations, we must inform you that 1. Nothing contained in this document is intended to be used, and nothing may be used or relied upon by any taxpayer for the purpose of avoiding penalties that may be imposed on such taxpayer under the Internal Revenue Code of 1986, as amended; 2. No written statement in this document may be used by any person or persons to support the promotion, marketing or recommendation of any federal tax transaction(s) or matter(s) contained herein; and 3. Any taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor with respect to any federal tax transaction or matter contained in this document.