Worried about Your Child’s Inheritance If They Divorce? A Trust Can Be Your Answer

You may love your son-in-law or daughter-in-law now, but that could change down the road. So, if you don’t want your money going to your kid’s future ex, here’s what you should do.

By Lisa Brown, CFP®, CIMA®

published 16 April 2021

in Features

(Image credit: Getty Images)

I recently met with a client to update her will, and her big question was whether she still needs a trust for her daughter. Her child has graduated college, is on her second well-paying job, got married and is now a new mom. Her daughter has been maturing into a responsible young adult. But there’s another factor that weighs heavily on my client’s mind – her son-in-law and the potential for divorce.

Time to Face Reality: Your Kids Don’t Want Your Stuff!

My clients don’t want money they’ve worked hard for to pass down to their son’s or daughter’s ex-spouse, if the unfortunate reality of divorce happens.

With the current federal estate tax exemption in 2021 at $11.7 million per person or $23.4 million for married couples, setting up a trust to save taxes upon death is not as much of a driving force as it used to be. Even if the estate tax limit is cut in half, most people will still be protected, as far as taxes go.

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The larger question becomes how well they think their children will handle receiving a large sum of money. As they watch their children mature, in most cases my clients eventually feel their child is up to the task. Yet they still want a trust because they worry about their adult child losing thousands, if not millions, of dollars of their inheritance as a result of a failed marriage. By establishing a trust as part of their will, these clients can help protect their child’s assets in a divorce settlement.

Let’s examine how this works. In many cases, if a child receives an inheritance and combines it with assets they own jointly with their spouse – such as a bank account, car or house – depending upon the state in which they live, the inheritance may become subject to marital property division if the adult child and spouse later divorce.

But if the child’s inheritance remains in a trust account, or they use trust funds to pay for assets only in their name, the inherited wealth can further be protected from a divorce. This gives the adult child their own assets to fall back on in the event of a divorce.

Getting the Best of Both Worlds from an Irrevocable Trust

One of my clients left his daughter’s inheritance in a trust after her first divorce because he was afraid his hard-earned dollars might end up squandered if she remarried. It turns out my client was spot on – she married again; it did not work out, but her second ex-husband never got a dime from her trust.

Trusts can be complex and involve extra administrative work and costs, which may cost more compared with leaving assets outright to your children. In addition, a person or company must be named as a trustee to oversee these funds throughout the trust’s existence. But many people are willing to pay these costs to protect their child’s wealth.

How do parents decide whether to leave assets in trust for their children because of the possibility of a failed marriage? Here are three scenarios to consider:

Children 18 or younger. If your child is under 18, you’re probably not thinking about the marriage/divorce angle! However, due to their youth, leaving assets in trust for them is often a good idea. A trustee will be named to oversee the child’s assets and will be able to guide them to make wise decisions with these funds. And the trustee has the power to deny any financial requests, which can be valuable if a young person is immature or easily influenced.
Is your child newly married? Nearly all couples are happy in the first years of marriage, but the road can turn bumpy as life becomes more stressful and complex — whether it’s a job loss, a decline in health, financial stress or simply the demands of raising children. Instead of deciding to set up a trust right after your child’s marriage, it’s best to watch how the marriage progresses over the next five to 10 years.
How is the marriage going? Even after five years or more, consider how comfortable you are with your child’s relationship and how you feel about your son- or daughter-in-law. If there is constant fighting or you simply have that bad “gut feeling,” setting up a trust for your child’s inheritance might be a wise move.

I encourage my clients to think about estate plans as five-year plans: Review your wills, trusts and other documents every five years. It isn’t necessary to constantly change these documents, but reviewing them periodically helps a person to carefully evaluate relationships, finances and the emotional dynamics of their families. In addition, an estate lawyer can modify or delete the trust during your life, as your family circumstances change.

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Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Lisa Brown, CFP®, CIMA®, is author of "Girl Talk, Money Talk, The Smart Girl's Guide to Money After College” and “Girl Talk, Money Talk II, Financially Fit and Fabulous in Your 40s and 50s". She is the Practice Area Leader for corporate professionals and executives at wealth management firm CI Brightworth in Atlanta. Advising busy corporate executives on their finances for nearly 20 years has been her passion inside the office. Outside the office she's an avid runner, cyclist and supporter of charitable causes focused on homeless children and their families.