In order for a prenuptial agreement to be valid, it should be written only after you and your future spouse have had enough time to negotiate satisfactory terms. In other words, the longer the time between the signing of the agreement and your wedding, the better. If you wait until the night before the wedding to give your future spouse a prenuptial agreement to sign, it probably won’t be considered valid later on, should it be contested. Time may also be needed to properly value assets such as a small business.
Obtain independent counsel
Although there is no requirement that you and your spouse be represented by separate attorneys when drafting a prenuptial agreement, both parties must be offered the opportunity to retain independent counsel. Be aware, too, that a judge may scrutinize the agreement more carefully when one attorney represents both parties. Both you and your prospective spouse should therefore have your own lawyers: If your attorney handles everything for both you and your prospective spouse, a court will probably rule that your spouse was not adequately represented, and the prenuptial agreement will be disregarded.
Prenuptial agreements drawn up without an attorney’s help may or may not hold up in court. However, certain variables within a prenup that an attorney would know to look out for could be overlooked by a couple drawing up an agreement alone.
Provide full and accurate disclosure of financial information
The key to a solid prenuptial agreement is full and fair disclosure of you and your future spouse’s income, assets, and liabilities. By presenting an accurate snapshot of your respective financial positions before you are married, you will both be able to track the asset gain or loss and come to a fair decision in the event of divorce.
Caution: If you are getting divorced and your spouse uncovers assets that you did not declare in your prenuptial agreement, a court may not uphold the contract. For this reason, lawyers often advise wealthy clients to overestimate their net worth rather than minimize it when drawing up a prenuptial agreement. Usually, both prospective spouses will exchange financial statements listing all assets and sources of income. This information can be obtained from sources such as bank statements, cancelled checks and old check registers, savings account passbooks, income tax returns (both personal and business), estate and gift tax returns, financial reports, loan applications, and income and balance sheets for a business. Both parties must also be thorough about disclosing any debts and financial obligations, including child support, alimony, or back taxes.
Make sure the agreement is free of any hint of duress
The court is likely to throw out any agreement that it determines was made under emotional stress, physical or mental disability, or threat of force. Many lawyers will videotape the signing of the agreement to show that both sides were fully aware of what they were doing and acted of their own free will.
Example(s): Amusement park developer Ronald Bump has decided to marry his girlfriend Darla, an aspiring acrobat. Having lost a substantial portion of his multimillion-dollar fortune to his first wife, Imelda, however, Ronald has a prenuptial agreement drawn up that would allow him to hold on to his remaining assets if his marriage to Darla fails. Although she is deeply in love with Ronald, Darla feels pressured and is uncertain about signing the agreement. “Why would Ronald do this to me two weeks before our wedding?” she asks Bumpy the Clown. “After all,” she rationalizes, “he left Imelda to be with me–and our twins are due in less than a month!” Bumpy tells her that Ronald probably wants to make sure that she and the babies are properly taken care of in the event of his death, and Darla reluctantly signs the agreement two days before marrying Ronald at the Bumptown U.S.A. theme park.
Example(s): Fast forward two years: Ronald and Darla’s prenuptial agreement is thrown out during divorce proceedings after the judge decides that Darla signed the agreement under duress.
Be fair
If your spouse is dependent on you financially, the provisions of your prenuptial agreement cannot leave him or her destitute in the event of divorce. It is against the law for the court to violate public policy (i.e., place your spouse on public assistance), and a judge will likely rule against you.
The fairness of an agreement, however, varies from state to state. Although several states have adopted the Uniform Premarital Agreement Act’s requirement that a prenuptial agreement not be unconscionable at the time it was executed, other courts have held that the agreement must be fair at the time of divorce. Some states require that it be fair both at the time of execution and at the time of divorce. Determining whether an agreement is unconscionable is based on the circumstances and facts of each case, as certain provisions are more likely than others to be considered unconscionable. In the case of death, most states include a provision in their probate laws preventing one spouse from completely disinheriting the surviving spouse. These laws generally give the surviving spouse the right to elect against what was provided in the will and instead take a set percentage of the deceased spouse’s assets. Nevertheless, prenuptial agreements in which a surviving spouse gives up his or her right to an elective share have been deemed enforceable. To ensure that the terms of the agreement will be enforced, the agreement should state that the new spouse agrees to waive all claims against specific assets and instead agrees to satisfy any marital property rights only with other assets in the event of divorce or death.
Distinguish between marital property and separate property
A prenuptial agreement should clearly differentiate between marital property and separate property. Marital property generally includes all assets that were acquired by either or both spouses during the marriage. Separate property falls into three categories: what you bring into the marriage, what you inherit during the marriage, and what you receive during the marriage as a gift. Be sure to familiarize yourself with the laws of your state pertaining to separate property and marital property, since different states have different definitions of what constitutes one or the other.
If you want to keep your assets separate when you marry, a trust is an excellent option. If the trust is set up in conjunction with a prenuptial agreement, assets placed in the trust are owned by the trust and are not considered marital property during the marriage, even in community property states.
Caution: If you set up a trust without a prenuptial agreement, you may have little or no protection, since a court could consider assets in the trust marital property subject to division. Your spouse’s signature on a prenuptial agreement would prove that you did not use the trust to fraudulently transfer your assets out of your spouse’s reach.
Consider including a “triggering event” within the agreement
When included in a prenuptial agreement, a triggering event (e.g., the sending of a registered letter) could be used to automatically initiate divorce proceedings. It would also distinguish between marital property and separate property as of the date of the event. Such a strategy could work to your advantage, especially if your agreement is based on providing your spouse with a percentage of your wealth and you are anticipating future earnings or an inheritance.
Tax considerations
Income tax
Executing a prenuptial agreement does not usually result in any immediate tax consequences. Tax consequences do arise, however, after one of two events–divorce or death–activates the terms of the contract. To properly plan for your desired tax consequences, you should be aware of the tax ramifications of all property transfers you made before signing the agreement. These not only include transfers made upon divorce or the death of you or your spouse but also transfers made at the time the agreement is executed and during marriage. .
Tip: Since tax laws are constantly changing, you should have your agreement examined periodically to ensure that it accurately reflects the wishes of you and your spouse.
Clarify tax responsibilities within the agreement
A prenuptial agreement should clarify who will pay to defend a tax audit, if necessary, as well as who will pay any assessed taxes, interest, and penalties. Some agreements stipulate that the couple will file as married filing separately so that the tax problems of one spouse will not affect the other–even though the couple will end up paying more taxes that way.
Tip: Even when spouses file their taxes as married filing jointly, one spouse may be protected against the actions of the other under innocent spouse rules, which were revised by the IRS Restructuring and Reform Act of 1998. Under these rules, although each spouse who signs a joint return is fully responsible for the accuracy of the return as well as the payment of tax, if one spouse failed to report income or reported deductions or other items improperly, the other spouse can sometimes be relieved of the tax, interest, and penalties related to these items.
Filing joint tax returns
If you choose to file as married filing jointly, both you and your spouse should be entitled to receive copies of the return and supporting documents each year. By doing so, you will avoid future problems in the event of divorce negotiations, if either you or your spouse cannot access necessary tax records.
Gift tax
Generally, property transfers made before marriage may have adverse gift tax consequences, whereas transfers made during marriage are not subject to gift or income tax. When drawing up a prenuptial agreement, therefore, you should stipulate that any transfer of property occur after the wedding.
Example(s): Ken and Sue have decided to get married. Ken owns a substantial share in Icy Frozen Foods that he wants to hold on to if the marriage doesn’t work out. He and Sue decide to draw up a prenuptial agreement that provides for Ken to transfer $250,000 to Sue in exchange for her release of all marital claims against any of Ken’s property in the event of divorce. A month before the wedding, Ken transfers stock worth $250,000 to Sue. Ken had purchased the stock several years ago for $50,000. The transfer of the stock causes Ken to have a taxable gain for income tax purposes of $200,000. In addition, Ken has made a gift (subject to the gift tax rules) of $250,000, and Sue’s basis in the stock is $250,000.
Example(s): If the transfer of the stock had occurred after the wedding, Ken would not have recognized gain on the transfer, since property transfers between spouses do not result in recognition of gain or loss. He would have also avoided the gift tax because of the unlimited marital deduction for gifts between spouses.
Estate tax
When a prenuptial agreement takes effect due to the death of a spouse, assets passing from the deceased spouse to the surviving spouse under the terms of the agreement may qualify for the estate tax marital deduction. The deduction cannot exceed the value of the adjusted gross estate, however, and only certain assets qualify for it. For a complete list of property that qualifies for the estate tax marital deduction, see Schedule M (Bequests, etc., to Surviving Spouse) of Form 706.
Questions & Answers
Does a prenuptial agreement mean that the prospective spouses don’t trust each other?
Perhaps, but a prenuptial agreement is generally grounded in realism rather than a lack of trust. For instance, an older couple marrying for the second time may simply want to protect the inheritances of their children. Some younger couples, on the other hand, might feel that they will save money in the future if the marriage doesn’t work out.
Can a domestic partner agreement that you had drawn up when you decided to live together be converted to a prenuptial agreement?
Yes, by following these steps:
Review your domestic partner agreement and make any changes and updates that you have both agreed upon. Rewrite the contract and call it a prenuptial agreement. Be sure to state that the agreement is in contemplation of marriage and does not take effect until you marry. Since there is no good self-help resource for writing a prenuptial agreement, have your agreement reviewed by an attorney. Even a small mistake on your part can invalidate your agreement. Lastly, sign your new agreement in front of a notary.
Can a prospective spouse waive his or her right to retirement plan benefits in a prenuptial agreement?
In general, if the retirement plan is covered by the Employee Retirement Income Security Act of 1974 (ERISA), an individual can not agree to waive his or her statutory right to benefits under the plan as part of a prenuptial agreement. While ERISA allows a spouse to waive his or her right to plan benefits (for example, a spouse can waive the right to receive a qualified joint and survivor annuity), only an actual spouse (not a prospective spouse) can exercise those waiver rights. In addition, the waiver must comply with specific statutory procedures. However, it may be possible for a prenuptial agreement to provide that the prospective spouse agrees to waive his or her rights once the marriage is consummated. Consult a qualified attorney if protection of retirement plan benefits is important to you.