The financial logic behind prenuptial agreements

This article will ... Detail the protection a prenuptial agreement provides both parties. Provide the necessary items to look for when creating a prenup. Address the emotional hurdles and paths to overcome them.

While divorce may be a difficult thought before a marriage has even begun, the reality is that roughly 41 percent of all first marriages end in divorce.¹ Another important statistic is that the average age at which people go through that first divorce is approximately 30.² This is also around the time when people are beginning to form a financial vision for their future. For most, then, proactively thinking through the possibility of divorce with a prenuptial agreement is savvy financial planning.

While once a taboo topic, prenuptial agreements are becoming more acceptable today, emerging as a wise premarital step for many couples, especially younger ones who arrive at the altar with greater debt and more assets than in earlier generations. A recent poll of Americans who have been married or are currently engaged show that 15 percent have signed a prenuptial agreement, commonly referred to as a prenup, In 2010, that number was just 3 percent.³

Contrary to the once prevalent notion that prenuptial agreements predict divorce, modern couples view them as a pragmatic approach to marriage — a partnership not only of hearts, but also of financial assets and liabilities. But is it right for everyone?

“Not every marriage needs one — a poorly thought-out prenuptial agreement can cause many problems and actually lead to divorce,” said Laurie Israel, a prenuptial agreement attorney and mediator who has written extensively on the topic.

Attorney Israel recommends prenuptial agreements for:

People from wealthy families.
Situations with a great disparity in assets.
People embarking on a second marriage, especially if the first involved difficult litigation.

Understanding prenuptial agreements

A prenuptial agreement is a written contract created by two people before marriage. A prenup typically lists all property each person owns, as well as any debts, and specifies what each person's property rights will be after marriage. Given the legal complexities and the variations in state laws, understanding the legal validity and the implications of a prenup is crucial. They are not just legal documents but financial planning tools that respect individual rights and state marital laws.

The financial logic behind prenuptial agreements

Prenups are often considered an essential financial tool to protect premarital assets, manage personal debt, and safeguard business interests.

For those with substantial family inheritances or children from previous relationships, a prenup provides a mechanism to ensure that assets are allocated as intended. Furthermore, with divorce rates persistently high and the realities of mortality, a prenup acts as a safeguard, ensuring the financial stability of both parties during unforeseen circumstances.

The basis of a prenuptial agreement

The bedrock of a prenup is full disclosure.

“If you don’t disclose everything, the prenup’s enforceability is weakened, because essentially you have defrauded your partner by not sharing all the financial facts,” Israel said.

Both parties must openly share their financial status, which includes assets, liabilities, income, and expectations of gains (note that income during marriage is outside a prenup’s scope). Decisions regarding which properties are to be shared (marital) and which remain separate are crucial, as are potential spousal support and the financial arrangements in the event of separation or death.

Creating a prenup

Drafting a prenup begins with a comprehensive inventory of both parties' assets. A financial professional can help provide an accurate snapshot of premarital possessions, including retirement accounts.

“Also, I find the best approach is to have a lawyer or mediator work with the couple to understand all the financial moving parts, and work through the parties’ feelings about how to handle the financial plan for the marriage,” Israel said.

To create the actual prenup document, each party should secure separate legal counsel to ensure unbiased advice and advocacy.

“Having one’s own counsel is important, especially for the less-moneyed spouse. It makes the prenup more enforceable,” she said.

Moreover, the prenup should be signed well before the wedding date to avoid any appearance of coercion, which could render the agreement void, as well as allow time for any uneasiness to subside.

Key elements and provisions

While a well-crafted prenup addresses property division in divorce, it can also be important in the event the marriage ends with the death of a spouse because inheritance rights can be included in a prenup. (Learn more: Wills and the basics of estate planning)

What about spousal support or alimony?

“Often, especially in first marriages, it is not feasible to contract for spousal support in a prenup, as there may be many contingencies at play,” Israel said. “However, while child support cannot be predetermined in a prenup, trusts and other arrangements for children's welfare can be included. (Related: 7 situations where a trust might help)

Clearing emotional hurdles

One of the greatest challenges in adopting a prenup is the emotional barrier, “especially for the less-moneyed partner,” Israel said.

Discussing a prenup requires delicate handling of candid financial conversations — a topic often avoided. Couples should work toward viewing a prenup as a testament to their commitment to handle financial responsibilities maturely. This requires thoughtful mediation.

“The best type of mediator is a collaborative divorce lawyer or a lawyer specializing in divorce mediation. They are most sensitive to the dynamics of marriage,” said Israel. Her advice is to find a lawyer who views a prenup as a marriage protection plan, not as an asset protection plan.

Enforceability and legal challenges

It’s important to ensure that the rights embedded in the prenup are fair to each spouse.

“Extreme one-sidedness, unless there is a good rationale for it, can lead to unenforceability and an unhappy marriage that is more divorce-prone,” Israel said.

In addition, the enforceability of a prenup hinges on proper execution. To withstand legal scrutiny, the agreement must be free of duress, fraud, and undue influence. Both parties should have ample time to review the document and seek legal counsel.

Common pitfalls include vague language and failure to disclose assets, both of which can lead to a prenup being contested.

The bigger picture: Prenups as part of financial planning

A prenup should be integrated into the couple's broader financial planning strategy. Consulting financial professionals can unearth potential tax implications and ensure that the prenup aligns with the couple's long-term financial goals. By doing so, a prenup reinforces a solid financial foundation for the marital partnership. (Learn more: 3 times when you probably need financial guidance)

Conclusion

Prenuptial agreements can be a practical step toward a transparent and secure marital relationship. By fostering open communication and clear financial understanding, a prenup can solidify the foundation upon which a marriage is built. Couples are encouraged to approach a prenup not as a forecast of doom but as a proactive, collective stride towards a responsible and loving union.