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May 01, 2023 Feature

Estate Planning Pointers and Pitfalls in Prenuptial Agreements

Jennifer S. Tier and Matthew W. McQuiston

Prenuptial agreements have become much more prevalent in recent years, as people are waiting longer to get married and more people are getting divorced and then remarrying. Both of these trends mean that people have more assets and potentially children from prior marriages or relationships. A prenuptial agreement is therefore an important tool to preserve and protect assets in the event of a divorce or death of a spouse. However, where a prenuptial agreement addresses the disposition of assets upon a spouse’s death, attorneys should make sure they consider some of the points detailed in this article to ensure that (1) the prenuptial agreement states what the parties mean and want in the event of a spouse’s death; and (2) the parties are taking the necessary steps to effectuate the terms of their prenuptial agreement.

Beneficiary Designations

Oftentimes, prenuptial agreements will allow for parties to dispose of their respective nonmarital or separate property as they desire. A prenuptial agreement will often also assign certain assets to a spouse in the event of a party’s death. However, there are several types of assets that have beneficiary designations, including retirement accounts, IRA’s, life insurance policies, bank accounts, and the like, which could undermine the terms of the prenuptial agreement. It is, therefore, important for an attorney to review a client’s beneficiary designations when drafting a prenuptial agreement. For example, many retirement plans must be paid to the surviving spouse unless the spouse consents to an alternate beneficiary. Make sure to review the plan requirements to ensure all provisions in the prenuptial agreement will be enforceable. For example, if a spouse must sign a consent for an alternate plan beneficiary, that should be a provision in the prenuptial agreement.

One pitfall may arise where a prenuptial agreement requires one spouse to name the other as a beneficiary but that spouse never fulfills that obligation after the marriage and then dies, leaving a third party as designated beneficiary. Certain retirement plans are governed by federal law, and the designated beneficiary will receive the asset, regardless of what a prenuptial agreement might say to the contrary. In this situation, the surviving spouse who was never named beneficiary would be left with limited remedies, such as pursuing a constructive trust or filing a claim against the deceased spouse’s estate. This can often be a tall order. If the deceased spouse has no estate against which to file a claim, the surviving spouse might be disinherited altogether, contrary to the parties’ intent at the time they signed the prenuptial agreement. In other words, the beneficiary designation can trump the terms of the prenuptial agreement. If this is a concern, practitioners might consider whether the plan allows for an irrevocable beneficiary designation, which would prevent a party from circumventing the requirements of the prenuptial agreement. An irrevocable beneficiary designation is the best way to ensure that a beneficiary designation complies with the terms of the prenuptial agreement. Alternatively, the prenuptial agreement could provide for a spouse have direct access to the beneficiary designation information or have an affirmative obligation for the account holding spouse to provide proof of the beneficiary designation periodically. This will allow the receiving spouse to verify that the beneficiary designations comply with the terms of the prenuptial agreement. However, if parties are still married (without divorce proceedings pending), there is no remedy in court that would allow a spouse to enforce the terms of the prenuptial agreement where a spouse is refusing to name the other as beneficiary, which is why being able to designate an irrevocable beneficiary is the best practice when available.

Estate Tax Planning

The current federal estate tax exemption is $12.06 million. Married couples can use each other’s exemptions to effectively double the federal estate tax exemption. This is called portability. However, many states have lower estate tax exemptions, and many do not recognize portability between spouses. When drafting a prenuptial agreement, you want to ensure that you do not inadvertently limit the parties’ ability to engage in tax planning in consideration of the federal and state tax exemptions. If estate tax planning is a concern (meaning the parties’ estate is close to the federal or state tax exemption), the prenuptial agreement should be drafted to allow for some flexibility in tax planning. An example of such tax planning could be the creation of irrevocable life insurance trusts or “AB” trusts to minimize estate tax upon the spouses’ deaths.

With an AB trust, the trust splits into two separate trusts upon the first spouse’s death, one for the surviving spouse and one for the decedent’s family. The family trust, often referred to as a bypass trust, would be funded with an amount equal to the estate tax exemption (whether this would be the state or federal exemption depends on the value of the estate and the state of residence). The balance would pass to the marital trust to take advantage of the unlimited marital exemption between spouses. For example, let us assume your client’s state has a $4 million estate tax exemption with no portability between spouses. Without an AB trust, the surviving spouse would receive the full $8 million upon the first spouse’s death but could only use her own $4 million exemption upon her death, resulting in estate tax on $4 million. With an AB trust, upon the first spouse’s death, $4 million would pass to the marital trust, and $4 million would pass to the family trust. The $4 million that went to the family trust would use up the first spouse’s exemption. The surviving spouse would then be able to use her own $4 million exemption upon her death. In other words, the AB trust would allow the spouses to use $8 million in exemptions and transfer the assets tax-free; whereas, without proper planning they would forfeit the first spouse’s exemption.

A prenuptial agreement can specifically provide for the parties to have an estate plan that maximizes the federal and state tax exemptions. However, at a minimum, the terms of the prenuptial agreement should not interfere the spouse’s ability to engage in such estate tax planning.

Businesses and Succession Planning

In both prenuptial agreements and estate planning, an ownership interest in a business needs to be precisely and carefully addressed. If one spouse owns a business, the parties should ensure there is proper succession planning and that ownership rights are referenced in the prenuptial agreement. For example, if the intent is for the business owner to transfer that business to a business partner or to children from a prior marriage, be clear in the agreement that the other spouse has no claim on the business. Depending on the state, a spouse might have a claim for the marital interest in the increase of the value of the business during the marriage, or for reimbursement to the marital estate for marital monies or personal effort expended on the business.

If the spouses intend to leave a business interest to the other spouse, it is best to ensure there is a proper succession plan in place and that the other stakeholders in the business are aware. For example, when a businessowner spouse dies without a clear succession plan, there is often litigation between the surviving spouse and the surviving business partner. One unfortunate outcome could be that the business is forced to liquidate or take on significant debt to buy out the surviving spouse’s interest. With clear succession planning, parties may avoid this devastating result. The prenuptial agreement should ensure that spouses have the ability to do appropriate succession planning for any business interest.

Spousal Share/Renunciation/Spousal Award

Prenuptial agreements may address a spouse’s ability to bequeath their separate or nonmarital property however they choose. You should make sure you are aware of your state’s laws with regard to renunciation of the will and spousal shares and draft the prenuptial agreement appropriately to provide for your client. Specifically, if one spouse’s will disinherits the other, most states allow the surviving spouse to renounce the will and take a statutory share of the deceased spouse’s estate. Parties to a prenuptial agreement may generally waive the right to renounce the other spouse’s will and forego the spousal share.

Additionally, many states provide for a spousal award, distinct from the spousal share that a spouse would get by renouncing a will. Whereas the purpose of a spousal share is to prevent spouses from disinheriting one another in their wills, the purpose of a spousal award is to provide for some short-term support for the surviving spouse to cover living expenses during the administration of the deceased spouse’s estate. Just as a spouse may waive the right to renunciation, a spouse may generally waive the right to assert a claim for a spousal award in a prenuptial agreement. However, the purpose of a spousal award is to provide temporary support, so you should consider whether your client will be able to support themselves (albeit temporarily) if their spouse dies before agreeing to waive a spousal award. For example, if the parties have a mortgage that one spouse typically pays for while the other spouse does not have the financial means to do so, then you may want to allow for spousal award in a prenuptial agreement. This will allow the surviving spouse to continue to pay the mortgage until the house can be sold instead of the house going into foreclosure. Notably, spousal awards often have priority over other claims against an estate. Spouses often have joint living expenses, and a spousal award will ensure the surviving spouse can support themselves for a transitional period of time.

Jointly Owned Assets

Regardless of what a prenuptial agreement might state to the contrary, how an asset is titled may dictate who receives the asset upon a spouse’s death. Therefore, it is a best practice to confirm how couples hold title to any jointly owned assets, particularly those that will pass to the surviving spouse by operation of law upon the other spouse’s death. For example, if Jane and John own a house as joint tenants with right of survivorship and Jane dies, John will automatically become the sole owner of a 100% interest in the property. Even if a prenuptial agreement states the property should go to the deceased spouse’s surviving children, John would be the owner due to how the property was titled, and the parties’ intent in the prenuptial agreement would be thwarted. To avoid unintended consequences, prenuptial agreements can provide for spouses to hold title to assets in a particular manner. Taking the example above, if Jane and John, in their prenuptial agreement, intend for the house to go 50 percent to John’s heirs and 50 percent to Jane’s heirs, then the prenuptial agreement should also provide that John and Jane shall title the house as tenants in common. Therefore, it is important to know how title is held for the parties’ assets and to write language into the prenuptial agreement regarding title so that the title matches the intent of the parties’ prenuptial agreement. The above applies not only to real estate, but could also apply to bank accounts, brokerage accounts, vehicles, or any other asset titled jointly.

Oftentimes, the purpose of a prenuptial agreement is to provide certainty in the event of a spouse’s death or divorce. It is therefore important to consider some of these estate planning nuances to ensure that the prenuptial agreement can be properly effectuated as intended by the spouses.

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Jennifer S. Tier

Partner, Davis Friedman

Jennifer S. Tier is a partner at Davis Friedman in Chicago. Her practice focuses on matrimonial law, custody/parental rights and responsibilities, parentage, and premarital and postmarital agreements.

Matthew W. McQuiston

Partner, Stern McQuiston Probate and Elder Law

Matthew W. McQuiston is a partner at Stern McQuiston Probate and Elder Law in Chicago. He practices in the areas of guardianship, estate administration and litigation, and estate planning.