Between the years of 2018 and 2042, America will experience the largest transfer of money between generations, known as the “great wealth transfer.” That’s right, our beloved baby boomers are the wealthiest generation in American history and will be passing down a staggering $68 trillion in wealth to their Gen X and Millennial children and grandchildren. Why are they so rich, you ask? Well, they benefited from the post-World War II economy, a ten-year bull market, and they all own homes! Lucky for us younger generations, we are going to be on the receiving end of that wealth in the next 20 years.
It goes without saying, then, that inheritance is a very contentious point of discussion in prenuptial agreements, as there may be a lot of money on the way for you one day. Note that there is a common misconception among many people that inheritances are automatically protected and cannot be touched, but that’s not exactly true. Your inheritance can very quickly become your ex-spouse’s property (partially) without a prenup.
Laws in Texas regarding inheritances (without a prenup)
There are two types of property division methods in the United States: equitable distribution (the most popular) and community property (the minority, and also what Texas follows). They both are legal frameworks that tell the court how to divide a divorcing couple’s property.
Texas is a community property state. In a community property state, there are two types of property: separate property and community property.
- Separate property is generally property acquired before the marriage and any gifts and inheritances received before or during the marriage. Separate property is usually not subject to division in divorce (with some exceptions).
- Community property is property accumulated during the marriage and is generally split 50/50, regardless of contribution.
As you can see, inheritances generally fall under the separate property category and are, by default, not split in a divorce. However, there are certain ways that your inheritance can change from separate property to community property and then be subject to division in a divorce. The way this may happen is through commingling.
Example of how you can lose your inheritance without a prenup
Commingling is best explained by example. John and Julie are married. Julie receives a $50,000 inheritance from her Great Aunt during their marriage. Julie then deposits the $50,000 into a joint bank account she shares with John that already has $50,000 of community property (i.e., shared money acquired during the marriage). If the inheritance cannot be traced out, then Julie’s inheritance is effectively commingled with the rest of the money in the bank account. The result? Julie may have just lost a portion of her inheritance in a divorce by simply placing the inheritance in a shared community bank account.
What could Julie have done better? Well, Julie should have placed the inheritance in a separate account. This would most likely preserve the inherited $50,000 as separate property. However, this would still not protect the interest on the $50k from becoming community property, subject to division in a divorce. That’s right–if that $50k gains interest, the interest is considered income. Income is considered community property, subject to division, even if that income comes from separate property. The only way to prevent the interest from becoming community property is via prenuptial agreement or postnuptial agreement).
How a TX prenup can protect your inheritance
A prenup can definitely create a layer of protection for your inheritance. If you don’t like the idea of your spouse potentially taking a piece of your inheritance, then a prenup may be a good option for you. Before we dive in, what is a prenup?
A prenup is a binding legal document between two soon-to-be spouses before getting married. It delineates what happens in the event of a divorce, covering topics such as asset division, debt division, and alimony. Specifically, it deals with what property you wish to keep separate and which property you’re okay with becoming community property. You may also limit or eliminate the possibility of alimony.
In addition, a prenup is a communication tool that you may use to align your financial and life goals with your partner. For example, a prenup forces you to talk about the future and how you want certain assets to be treated. Each partner bears all, and it’s a great way to really understand each other’s expectations. For example, does your soon-to-be spouse know that you maybe want to keep that inheritance you expect from your Grandpa separate? Now’s the time to facilitate that conversation and make sure you both are aligned.
How can a prenup specifically help protect your inheritance? Essentially, you can draft into your prenup that any future inheritances, including any interest created from separate property, will remain separate property, not subject to division in a divorce. As long as your prenup is legally valid, stating that your inheritance (plus interest) is your separate property prevents a judge from adding that inheritance to the community pot and dividing it up in a divorce.
Example of how a prenup can help
Joe and Angela are newly engaged. They discuss having a prenup and agree that it’s a good idea. Angela’s main use for the prenup is to protect her inheritance that she expects from her Grandpa. She’s been told it’s going to be around $200,000. Angela wants to make sure that her Grandpa’s hard-earned money stays in the family. So, in their prenup, Angela makes sure to delineate that all inheritances (plus any separate property interest) are separate property. Angela was advised not to deposit the inheritance into a joint bank account that she shares with Joe. The prenup is finalized, and they go on to have a happy and successful marriage. Angela feels relieved knowing she has that extra layer of protection, almost like marriage insurance, on her Grandpa’s hard-earned money.
Why postnups are another option to protect inheritances
If you choose to forego a prenup, there is always the option to get a postnup during the marriage. A postnup is a contract that you create with your spouse during the marriage. This is opposed to prenups, as they are finalized before the marriage. Postnups and prenups are similar because they both allow you to contract regarding topics like property in the event of a divorce.
A postnup can also protect your inheritance, albeit not quite as thoroughly. A postnup is generally not as strong as a prenup, and postnups are frequently thrown out in courts across the country. Why is this? Well, partially because prenups have a longer history in the U.S. and have a better reputation within the court system. Your best bet is to get a prenup. However, if you did forgo this option, a postnup is your next best bet.
Speaking with your parents/grandparents about your inheritance
One of the things you should do before getting a prenup is to speak to your parents/grandparents (or whatever benefactor you may receive money from) regarding your inheritance. For example, you may need to include the exact (or at least estimated) amount of the expected inheritance on the prenup. This is generally included on the financial schedule along with your other assets during the financial disclosure phase of the prenup process. So, if you don’t have a good idea of the family wealth, then now is the best time to figure that out.
In your prenup, you also have the choice of not protecting your inheritance. Meaning you can allow inheritances to become community property, subject to division upon divorce. If this is what you want, then you should also let your parents/grandparents know! They might have their opinions, but ultimately, this is your prenup and your marriage. It’s a contract between you and your soon-to-be spouse and no one else at the end of the day.
Millennials and Gen X are set to receive nearly $68 trillion in inheritance. It’s no wonder so many people ask us about inheritances! Even if it’s not quite in the trillions and more like $50,000, ask yourself this: would you be okay with your future ex-spouse taking a cut? If the answer is no, then you need to get a prenup to protect that inheritance.
Christopher (“Chris”) is a Partner at Fears Law and he understands that every prenup is as unique as the couple requesting it. As such, it is both his goal and his practice to make sure that his clients’ prenups are tailored to fit their exact expectations and needs. Chris prides himself on his ability to deliver compassionate and clear consultations that result in client education and empowerment.