Could Your Children Lose Their Inheritance in a Divorce?

If you have adult children, there’s a good chance that they are either married, or that they will be. Watching our kids grow up, find love, and start families of their own is one of the great joys in life. As a parent, you probably anticipate that your children will inherit some of the assets you have accumulated during your life, using it to build a better future for their own family.

Unfortunately, the future you are dreaming of for your children may not materialize in quite the way you imagine. As you have no doubt heard, the divorce rate for first marriages in the United States hovers somewhere around 50%. For second marriages, it’s even higher. What that means is that if your child inherits money or other assets from you, the potential exists for their spouse to get some of those assets in a divorce.

Hopefully, your children will find themselves in the 50% of couples that stay together. But if they don’t, a bit of advance planning on your part can protect their interests without causing hurt feelings within the family.

Inheritance, Divorce, and Property Division

To understand how to protect your child’s inheritance in a divorce, you first need to understand a few things about property division in divorce. In Michigan and most other states, marital property in a divorce is subject to “equitable division.” What that means is that marital property will be divided in a way that is fair under all the circumstances. While that may not be exactly 50/50, in practice, it is usually pretty close.

The real issue, for purposes of our discussion, is what “marital property” means. Marital property, in most states, includes any property acquired by either spouse during the marriage, with some limited exceptions. Inherited property is often one of those exceptions. In Michigan, property inherited by one spouse during the marriage is still considered “separate” property, not subject to division in a divorce.

So what’s the problem? Well, property that starts out separate doesn’t necessarily stay that way. If an inherited asset is commingled with a marital asset, it is then considered a marital asset.

So what’s the problem? Well, property that starts out separate doesn’t necessarily stay that way. If an inherited asset is commingled with a marital asset, it is then considered a marital asset. Let’s say Mary inherits $20,000 from her father. If she places that money in a new savings account, it remains separate. If she and her husband Jeff divorce, the money in that savings account should not be subject to division. But if she places the inherited money in a joint checking account that she owns with Jeff, from which their bills are paid and into which their paychecks go, it can become impossible to separate out the inheritance, and a court may not even try. The entire joint checking account would be considered marital property in a divorce.

Estate Planning for Asset Protection

Fortunately, there are a number of estate planning options that protect assets you might leave your children from a divorce. (As a bonus, many of these can protect assets from other creditors, too, or even from your child’s own ability to manage significant assets).

You probably won’t be surprised to learn that the solution to this potential problem involves creating a trust. Not all trusts provide protection from a divorcing spouse or other creditors, so it is important to let your estate planning attorney know that this is one of your goals for your estate plan.

There are many types of trusts, but they all fall into two categories: revocable, meaning they can be revoked during the creator’s lifetime, or irrevocable. The primary advantage of revocable trusts (also called revocable living trusts) is their flexibility: you can use the assets in the trust as if they were your own during your lifetime, or cancel the trust altogether if you wish. However, if a revocable living trust is not drafted with creditor protection in mind, it may not provide the security that you want for your beneficiaries.

You lose flexibility with an irrevocable trust; once you place assets in the trust, they are owned by the trust and you cannot reclaim them. Irrevocable trusts such as domestic asset protection trusts (DAPTs) or third-party discretionary trusts are often used to shield beneficiaries’ assets from creditors or divorcing spouses. If you create such a trust and fund it with your own assets, it offers protection for you as well, since the assets in the trust will no longer belong to you.

If you wonder whether your existing estate plan can protect the assets you intend for your children in the event of their divorce, it’s time for a review. We invite you to contact our law office to schedule a consultation.