How to Protect Your Child's Inheritance From Divorce

Most parents' natural inclination is to make their children happy by welcoming potential sons- and daughters-in-law into their family with open arms.

Of course, that's a noble impulse and no one would disagree that it's good to nurture a harmonious relationship with your child's life partner.

However, it's equally important to protect them by considering potential future issues that your adult child may not. Unfortunately, those considerations include divorce - and the loss of a significant portion of your child's inheritance if there is no prenuptial agreement signed before marriage.

“This is a big conversation I've had with a lot of my clients who are parents," said Jason Niell, national trust administration manager for City National Bank Trust and Estates. “You can't always pick your kid's spouses and you can't always predict what will happen in their marriage down the line."

While it may be a touchy topic to tackle, there are very legitimate reasons to want to protect your children's inheritance.

 

How to Explain the Importance of Wealth Transfer Protection to Children

It's important to understand — and communicate to your child — that wanting to protect their wealth isn't just about money or completely cutting the divorced spouse off financially.

Heirlooms like jewelry or art, or a beloved family summer home, are all items parents may want to safeguard to ensure they stay in the family for many more generations to come. “Protecting wealth is not just accumulated cash, investments, income and retirement assets. It's vacation homes, family homes and farms. It's also family treasures and historical family information," said Niell.

“Many times, we see when someone passes away or gets divorced, there's just not an understanding of who's supposed to get what when you start talking about tangible property. Things like photo albums, family history and more could fall into the hands of someone who was not intended to inherit those family treasures. Unfortunately, you see stories where grandchildren and great-grandchildren lose all the information about their family history because it ended up going with another side of the family."

Additionally, if your child divorces, their ex-spouse may go on to make a new family. If they inherit your wealth, that legacy will pass to their new spouse and children who are not necessarily going to stay part of your family.

Conversely, if your child goes on to remarry, they may not be able to bring some of those valuable financial and intangible assets into their new relationship.

Understandably parents want to safeguard against those kinds of losses. Fortunately, there are ways parents can defend a child's legacy, while also allowing them as a couple to benefit from a wealth transfer during their time together.

 

Leveraging the Protective Power of Trusts to Transfer Wealth

The best method for parents to structure a wealth transfer to protect their child's inheritance is via a trust.

One efective way to shield your family's wealth — whether from things like divorce or from anyone who may try to take advantage of them — is through a trust with a corporate trustee to oversee it. Instead of distributing wealth outright to a child, parents can use a trust to dispense it in increments.

Parents can set up trusts to provide for a variety of things like health, education, maintenance, and support — often abbreviated HEMS. The trust would normally provide for income and HEMS, while keeping the child at arm's length from the principal assets.

Because the child doesn't own the trust, they are only entitled to income and other distributions for their own needs.

Niell noted that a trust can also be set up to cover what to do in the event of a parent's or child's death.

“Trusts are the most common vehicle to protect and impact assets with some control. Parents can activate a trust while they are still living or have a trust created at the time of their passing," he said.

"Trusts can also limit distributions made to current or future spouses. They can cover where assets go after the death of their child, to make sure they go specifically to their heirs and the rightful grandchildren. Trusts may specify what happens with stepchildren and more."

 

Don’t Inadvertently Disinherit

A major benefit of trusts is that they can be very specific and you can create one for practically every potential outcome.

It's important to consider hiring a professional estate lawyer to help you establish a trust, so that you can ensure that a trust covers all potential issues.

"For example, you don't want to accidentally disinherit a child's spouse," said Niell. "I've seen many cases on both sides where the parents have had a very longstanding relationship with a spouse, and they inadvertently disinherit that person after a death even though they don't mean to. If their daughter or son were to pass away, they actually wanted that spouse to inherit, but they didn't put that caveat into the document."

 

Communication Is Key

Finally, it's not enough to protect your child's inheritance with a trust. To maximize a trust's success, it's equally essential to communicate with your child what you're doing and why.

It's vital to communicate with your child your intentions so there are no surprises and, hopefully, your children will appreciate that you're doing this for their protection.

Niell agreed. “It can be difficult to speak about death, divorce and the future. Whether it's talking about a prenup for a marriage or having a preemptive conversation about divorce, these are discussions that people are reluctant to have because they have to forecast the future," Niell said.

"But what they fail to realize is, if they don't forecast the future and play the 'what if' game, it's going to make life that much more difficult when those actual events happen in the future. The difficult conversation today saves them the difficult events of the future."