Where Divorce and Estate Planning Intersect
By Sean Saari, CPA, ABV, CVA, MBA, Partner, Advisory Services
More often than not, it is incredibly stressful for spouses to navigate the process of divorce. They are juggling myriad heavyweight issues that will forever impact and change their lives. Some of these considerations include parenting plans and financial matters, both of which involve decisions sitting atop the emotional toll that accompanies every divorce. One aspect that is frequently overlooked, however, is how a pending divorce impacts the estate planning (or lack thereof) the couple may have previously undertaken, and how the spouses’ post-divorce estate plans may play a role in settlement discussions. This is particularly true in the case of high net worth individuals.
While divorcing spouses understandably focus most closely on the immediate financial ramifications that will result from the divorce – who is getting the house, the amount of the property settlement, spousal support, etc. – those financial consequences are not confined to a singular point in time. Rather, they are likely to impact the remaining lifetime of each spouse. As a result, it is critically important that each spouse reassess his or her estate plan in light of the outcome of the divorce.
Since revising one’s estate plan in light of a pending divorce is so important, spouses should start making these changes prior to the divorce being initiated or finalized, right? Wrong! Simply put, you are married until you aren’t, which makes it difficult to make unilateral changes to one’s estate plan during the pendency of the divorce. Instead, potential estate plan changes should be outlined and ready to be implemented immediately after the divorce is finalized.
The last thing many divorced individuals want is for their ex to receive the proceeds from a life insurance policy on which they never bothered to update the beneficiary. While these issues are sometimes governed by state law, they are too important to leave to chance, and a clear post-divorce plan should be contemplated and executed immediately following the divorce’s completion.
So what should someone do to address his or her estate plan in connection with a divorce? The first step is to examine the existing estate, trust, and other planning documents and determine what provisions will need to be revised. Key documents to review include:
- Healthcare power of attorney
- Power of attorney
- Life insurance policies
- Life insurance trusts
- Existing trusts (both revocable and irrevocable)
- Guardianship for minor children
- Beneficiary designations on life insurance policies and qualified retirement assets
For spouses with significant wealth, it is also important to obtain and review gift tax returns filed in prior years to determine the level of gift-splitting utilized in the past, as well as the remaining estate and gift tax exemptions available to each spouse.
Estate planning can be complicated enough when both spouses are seeing eye-to-eye and working in tandem. The emotional toll that comes with divorce only compounds this complexity. This makes it all the more important to begin with the end in mind in order to avoid unintended consequences. Each spouse’s divorce and estate counsel, along with other key advisors such as accountants and wealth managers, must work together to proactively plan for what life will look like from a financial perspective on the other side of the divorce. There are a number of moving, yet interconnected, financial components, and it is important that these complex issues be viewed from multiple angles in order to ensure the desired outcome is achieved.
In addition to the need to update an individual’s estate plan in connection with his or her divorce, the estate plan itself may actually serve as a useful tool to reach a settlement. While such flexibility is often not available when a case goes to trial, creative settlement structures outside the courtroom can utilize aspects of estate planning to help bridge gaps in disputes over asset values and property division. For example, an individual may offer to leave his or her spouse as a beneficiary on a life insurance policy in exchange for a smaller property settlement.
Another creative estate planning technique may be to begin transferring assets to the couple’s children (or trusts for their benefit). There may be a reticence to transfer assets to the future former spouse, but the couple may share the common goal of passing assets to their children. This is particularly true where it is the intention of the divorcing parties to leave their assets to their children at death. An added benefit is that such transfers may make good use of any remaining gift tax exemption available to the spouses, particularly since discounts for lack of control and lack of marketability may apply to the assets transferred, thereby allowing more wealth to be transferred to future generations free from transfer taxes.
Divorce can be complicated enough without throwing estate planning into the mix, but failing to do so may produce unintended results and consequences that can be avoided by careful planning. While the estate plan is not a silver bullet to settle all divorces, it offers a potentially powerful tool that might be utilized in structuring settlements that achieve the goals of both spouses.
In addition, the estate plan itself may end up serving as a useful tool in structuring a settlement that is palatable to both spouses. While the primary focus of the divorce process is to separate the spouses and their financial affairs so they can move on with their separate lives, it is important not to lose sight of a divorce’s long-term impact and what needs to be done to ensure each spouse’s estate plan is appropriately updated to reflect their new stations in life.