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Classification of Gifts, Inheritance, and Life Insurance in the Context of Divorce

When your client provides you with a list of all assets and debts of the marriage, be sure to have gifts, inheritance, and life insurance policies listed separately from other items obtained during the marriage. Some states have specific rules for the distribution of these types of assets, while others follow basic community or common law distribution principles.
In most common law states, gifts acquired during the marriage are treated as separate property. However, because common law states divide property equitably, gifts which increase one spouse’s separate property are sometimes taken into account when the court divides the marital property. In such situations, the gift may be separate property, but it does actually reduce the marital property distributed to the spouse owning the gift. In other common law states, though, gifts and other separate property may not be considered in determining an equitable distribution of the marital property and do not affect the marital property distribution.
In community property states, gifts acquired during the marriage are generally presumed to be community property unless the spouse acquiring the property can prove that it is a gift and can trace the source of the funds. Also, if the gift is later sold, there must be a paper trail to show the source of the funds.
Common law states vary on how they characterize inheritance. In some states, inheritances are subject to equitable distribution. In others, inheritances acquired during the marriage are considered separate property. However, the separate property may or may not be considered prior to making a distribution of the marital property, as discussed with gifts above.
Community property states presume that inheritances acquired during the marriage are community property and subject to an equal division. In order to be classified as separate property, the spouse must prove acquisition by inheritance and be able to trace the source of the property.
Life Insurance
The type of life insurance policy must be considered for a distribution of life insurance policy. Also, whether the state is a common law or a community property state is an important factor.
In common law states, term life insurance policies are generally treated as separate property, no matter when they are acquired. However, whole life insurance policies are generally marital property, and the cash surrender value is subject to equitable distribution. The property settlement should clearly state the type of insurance policy, how it is to be distributed, and whether or not the spouse owning the policy is required to name the other spouse as the beneficiary. If not, it is important to advise your client to have the beneficiary changed to someone other than the spouse. Otherwise, the former spouse will be entitled to the life insurance proceeds.
In community property states, the time of acquisition and the source of the funds used to pay the premiums usually determine the nature of the property. If the policy was acquired prior to the marriage and with separate funds, the policy is generally separate property. However, if the policy was acquired after the marriage and/or the premiums were paid with community funds, the policy is generally deemed community property.
It is important to property draft the settlement agreement by accurately detailing each spouse’s assets. In order to do this, you must thoroughly explain the need for an accurate listing of assets and debts to your client early in the client interview process. Many clients feel that too much detail is required, don’t want their personal information publicized in legal documents, etc. However, without an accurate listing, there is no way to make sure that your client gets the assets to which he or she is entitled during the divorce action.