Divorce fundamentally changes the assumptions underlying a married couple’s estate plan. The marital deduction, the two-trust structure, the survivorship provisions, and the beneficiary designations all depend on the existence of a marriage. When the marriage ends, these provisions may be revoked by operation of state law, may become inapplicable, or may produce unintended results.
Estate plans should be reviewed at the earliest sign that a marriage may end. Waiting until the divorce is final risks a gap period during which the existing plan could produce catastrophic results if one spouse dies.
State Law Revocation on Divorce
Most states have enacted statutes that treat a divorce as automatically revoking certain provisions in favor of the former spouse. The scope of these revocation statutes varies by state, but they commonly revoke bequests to the former spouse in a will, beneficiary designations in favor of the former spouse on life insurance and retirement accounts, powers of appointment granted to the former spouse, and fiduciary appointments (executor, trustee) of the former spouse.
The revocation is automatic upon the entry of the divorce decree. No affirmative action by the decedent is required. The practical effect is that the estate plan is read as if the former spouse predeceased the decedent, causing the property to pass under the alternate provisions (typically to children or other contingent beneficiaries).
These statutes protect against the common outcome of dying after divorce without updating the estate plan. However, they are not comprehensive. Revocable trusts may or may not be covered depending on the state. Beneficiary designations on accounts governed by federal law (ERISA plans, for example) may override state revocation statutes. Jointly held property may pass by operation of law regardless of divorce.
During the Dissolution Process
The period between separation and final divorce decree is the most dangerous. The marriage still exists legally, but the relationship may have deteriorated to the point where the existing estate plan no longer reflects either spouse’s intentions.
Several issues arise during this period. The marital deduction remains available because the marriage is still legally recognized, but the surviving spouse may inherit assets that the decedent would not have wanted the estranged spouse to receive. The surviving spouse may still serve as executor, trustee, or agent under a power of attorney. The surviving spouse may have access to accounts and assets through joint ownership or beneficiary designations.
Estate planners advise clients in the dissolution process to update their estate plan as soon as practical, even before the divorce is final. A new will can revoke or modify bequests to the spouse, subject to court orders that may restrict asset transfers during divorce. Beneficiary designations can be changed, subject to court orders and QDRO requirements for retirement plans. Powers of attorney can be revoked and replaced.
Tax Treatment of Intraspousal Transfers
Property settlement transfers between spouses during the divorce process qualify for the unlimited marital deduction for estate and gift tax purposes. IRC § 1041 treats transfers between spouses and former spouses (if incident to divorce) as gifts. The recipient takes the transferor’s basis, so transfers are generally tax-free.
This favorable tax treatment applies to transfers made during the marriage and to transfers made pursuant to a divorce decree or separation agreement if made within a specified period. The tax-free treatment makes property settlement negotiations easier because neither party faces a tax cost on the transfer itself.
After the Divorce
After the divorce decree is entered, the marital deduction is no longer available. The former spouse is treated as a non-spouse for all transfer tax purposes. Any assets that the former spouse receives at the decedent’s death would not qualify for the marital deduction and would be subject to estate tax (to the extent they exceed the applicable exclusion).
The estate plan should be completely rewritten after divorce. Even though state revocation statutes eliminate most provisions in favor of the former spouse, a new plan is needed to name new beneficiaries, appoint new fiduciaries, address custody and guardianship provisions for minor children, and restructure the trust architecture for a single person rather than a married couple.
The credit shelter trust and marital trust structure is no longer relevant after divorce. A single person’s estate plan typically uses a revocable living trust (to avoid probate), direct beneficiary designations, and possibly generation-skipping trust provisions for descendants.
Planning in Contemplation of Marriage
The opposite situation also requires attention. Before marriage, an individual may want to settle property in a separate trust to insulate it from a future spouse’s potential elective share. Premarital planning options include irrevocable trusts funded before the marriage, prenuptial agreements that waive or limit elective share rights, and timing strategies that take advantage of the marital deduction for transfers made after the wedding.
Individuals who own homes should also consider the IRC § 121 capital gain exclusion on personal residences. If both parties own homes, the timing of the sale relative to the marriage can affect how much gain is excluded.