Greg S. Pettys of ASPIRE GROUP, INC.
[ Editorial Note: The opinions shared here are not necessarily those of Smart Stepfamilies. They represent the opinions of the author. These ideas are shared with the expressed intent of stimulating your thoughts around financial planning and decision making. ]
Shared Covenant Agreements—what are they and when and how should they be used in the financial formation of remarriage or a stepfamily? This article will address these topics.
At first glance it does resemble what is called a prenuptial agreement. However, unlike a prenuptial agreement it is not based upon the possibility of a divorce (trying to anticipate how you will act during an ensuing divorce can sow seeds of distrust in the marriage). Instead, the Shared Covenant Agreement is designed to actually clarify many emotionally charged issues and to reaffirm commitment to the permanency of a remarriage. Shared Covenant Agreements are not for every remarrying couple, but if done in the right spirit will allow a Christian couple to focus on the detailed vision of an optimistic future together.
Please be sure to find and work with a qualified trust and estate lawyer who shares your Christian values and ask about whether the Shared Covenant Agreement is appropriate in your case. The Shared Covenant Agreement should always be a part of an overall financial and estate plan which incorporates other financial tools.
One word of advice: pay the money to get it done right rather than just jotting it down on a napkin or putting together a “homemade” version. Provide your financial planner all the legal and financial documents necessary so he or she can adequately advise you and give you confidence that your intentions are being carried out.
A Shared Covenant Agreement or SCA is a written agreement drafted by a qualified trust and estate lawyer who shares your Christian values. It is not merely a legal document though it can and should be entered into with legally binding authority. A SCA is a detailed declaration of loving financial intentions between a couple. Based upon Christian values, an SCA is more than legally binding—it is morally binding. The specific stipulations can vary but will always center around the loved ones within the blended family network (including the homes of former spouses/parents). It can include specific commitments about the financial support, rights, roles, responsibilities, and overall total wellbeing of spouses, children, stepchildren, grandchildren, stepgrandchildren, parents, stepparents, grandparents, stepgrandparents, and other significant relationships.
For example, consider Greg and Jenny Smith, a middle aged Christian couple who are contemplating remarriage. If things keep moving in the right direction their big day is only six months away. Greg has two young boys from a previous marriage and Jenny a teenage girl named Melissa; they both would like to have at least two more children together. Greg is a successful land developer and has recently received a modest inheritance from his deceased aunt. He has had difficulty keeping debt out of his life. Being a CPA who “dots the I’s and crosses her T’s” well, Jenny, on the other hand, is very good with managing money. She currently has been caring for her elderly mother Eunice. Her mother is generally healthy, but recently has begun to forget some important things. Jenny is concerned that soon she may need to make good on her promise to move mom in with her. Greg’s ex-spouse has made it clear that she will not allow him to take the boys out of the state and furthermore that they will one day attend in-state colleges. Jenny never hears from or sees her ex-husband who has had legal problems and a lien on their still jointly owned home. Greg has not yet had the nerve to tell Jenny that he definitely wants his business and recent inheritance to go to his boys instead of Jenny or Melissa. He is willing to make provision them and any future children they may have together, but wants his children to maintain control of his business and received inheritance.
What did the creation of a Shared Covenant Agreement do for this couple? First, it required them to sit down and share all their “financial facts,” strengths, and weaknesses. Jenny found out about Greg’s debt problem. Greg discovered that his future mother-in-law may live with Jenny. Together they agreed to purchase long term care insurance for her mother and to work toward assisted living support instead of carrying all of the responsibility themselves.
Greg communicated his interest in a Qualified Terminable Interest Trust or QTIP which was drafted by his attorney. In the event of his death it assures Jenney income from the inheritance he received from his aunt, and also includes provision for his sons. In addition, the SCA motivated Greg to finally have a buy-sell agreement written for his business. That document, which gives his sons first rights of refusal to buy his company, is now reflected in the SCA along with references to the QTIP. Plus, the SCA clearly spells out that Greg is going to take out a million dollars of permanent life insurance on himself and name Jenny, her children, and any future children they may have together as the beneficiaries. The policy will be owned by a trust out of their estate and will provide for their needs.
Finally, the Shared Covenant Agreement addressed how they would manage money on a daily basis: Jenny would take oversight of their joint budget and they would share a joint savings account (but each would maintain 40% of all liquid assets in separate accounts for the first 5 years of the remarriage). They also agreed that Greg would seek counseling and become accountable for his debt so they could eliminate it.
In the end, the SCA provided this couple peace of mind in terns of finances and their relationship.
What are the advantages of a Shared Covenant Agreement?
Shared Covenant Agreements allow for a time of full and complete discovery of all your financial matters. There must be integrity and complete transparency. This full and fair disclosure is a legal requirement with a prenuptial agreement but a moral one in the Shared Covenant Agreement. You must share the intimate details of both of your balance sheets and income statements. You may discover important facts about each other that have been hidden or previous unshared. You will find out each others income, assets and liabilities, and any impending inheritances or big business deals around the corner. If the possibility of highly personal information being publically disclosed is a deterrent, you can also ask the attorney for a “confidentiality agreement” to insure that the information is held confidential. Creating a Shared Covenant Agreement without complete financial disclosure could later undermine trust in the marriage.
You will, also, gain from the process of creating a Shared Covenant Agreement by communicating openly about the topic of money. Before marriage is the best time to work through money matters. You may discover, for example, that merging all of your separate financial assets and debts may be a recipe for a disaster.
The Agreement is essentially allowing you to “write the rules for your marriage.” It takes your marital vows and brings much needed detail to what are often complex stepfamily issues. Many remarrying couples have considerable wealth to protect and certain hard to value assets that need clarity for proper estate planning. On the other hand a Shared Covenant Agreement also protects you from a debt-laden second spouse. It helps you determine, before tying the knot, just how much of their credit card you will be personally liable for in the event the marriage does not make it for some unforeseen reason. Keeping some assets in only one of the spouse’s names might be what is necessary to protect them from any future creditors.
More importantly to many of us in remarried situations, the Shared Covenant Agreement alleviates worries about whether your children from a previous marriage will be provided for at a level that they are accustomed to. It ensures that your estate is distributed as you wish.
If you have or foresee having a business or professional practice, having a Shared Covenant Agreement is a must in order to have it equitably valued and disposed of if the surviving spouse can or will not run it at the owner’s death.
For those who expect to one day receive sizable inheritances during marriage, having a Shared Covenant Agreement could alleviate any concerns that the person delegating your inheritance has regarding your second marriage. Without this loving agreement in place they may hold back on your portion of the inheritance due to their inability to relate and get along with your spouse-to-be.
Older couples entering into second marriages may have retirement issues or long term care issues to grapple with. This is another reason for having an Agreement.
Let’s say that one of the spouses has a professional degree or advanced licenses and the other is a stay-at-home parent. In the event of a divorce the stay-at-home partner will benefit from a Shared Covenant Agreement especially when little or no shared property exists, because it provides income from their spouse.
What are the disadvantages of a Shared Covenant Agreement?
Some are opposed to Shared Covenant Agreement on moral or philosophical grounds because it seems to plan for divorce. Is this written Agreement an example of mistrust or a lack of faith in God? Could even raising the subject potentially have a negative effect on your relationship? It is important not to force your partner to enter into this discussion; doing so could bring harm to the relationship. When first bringing up the subject, test the water carefully to see how open your partner is to the topic. Do not pressure or coerce the other to sign any or you will completely ruin the foundation of trust. If bringing up the topic results in significant negativity speak directly to your financial planner to see if there may be any other way to achieve the same desired outcomes and financial goals without using the Shared Covenant Agreement (see “Alternative Options” below).
Special Categories of Marital Property that create the need to consider a Shared Covenant Agreement
Shared Covenant Agreements can be especially helpful with these five types of marital properties:
1. Pensions and other retirement benefits
2. Stock Options
3. Professional licenses and degrees
4. Closely held corporations and other businesses
5. Professional Goodwill
Pensions and Other Retirement Benefits
You will save a lot of time, hassle, and costs if you have the largest amount of wealth in Qualified Retirement Plans and Pensions by entering into a Shared Covenant Agreement.
In most states, Pensions and Other Retirement Benefits are considered marital property if any part of them is earned or accrued during your marriage. This is true even if you cannot access your retirement funds or you do not actually receive your pension benefits until many ears after your marriage has ended. Further, this is true even if your pension is not vested at the time of your divorce and you still must work additional years in order to guarantee your payout.
Your ex-spouse will almost always be entitled to their portion of benefits. For example, let’s say that you were married only ten years and your pension required you to work for twenty in order to be vested. That does not mean the ex-spouse is out of the picture. He or she can still claim half of the pension.
Two methods of dividing the Pension and Retirement plans are being used in these cases. One is to buy out the Pension holding spouse’s share by offering a lump sum cash payment or making up the difference with other marital assets.
The second method is for the pension holder to pay the other spouse when they are actually paid by using a Qualified Domestic Relations Order or “QDRO”. This saves the Pension holder from having to pay before the pension is actually paying out.
The Qualified Domestic Relations Order may also allow the Pension holder to avoid all the taxes on paying a life time of pension income out to the ex-spouse and instead will require the spouse that gets the QDRO to pay the taxes as money is received in lump sum.
Social Security Benefits are a sub-topic under Pensions and Retirement benefits. Unlike other types of retirement benefits, Social Security benefits do not count as marital property in divorces. However, you may be able to receive spousal Social Security benefits based on your spouse’s Social Security contributions even after you have divorced. This is true as long as the spouse was eligible for Social Security benefits. See the website of the Social Security Administration at www.ssa.gov for more details.
Stock Options are another area where spelling out your commitments in a loving way within the Shared Covenant Agreement is a stabilizing factor to the finances and the remarriage. Options like these often provide employees the opportunity to by or sell the company’s stock at a predetermined price called a “strike price” after a certain period of time. They are typically nontransferable and nonassignable.
If you are awarded stock options during your marriage, most courts will consider those options to constitute marital property even if you do not actually exercise those options during your marriage.
This is still the case even if the stock options are not yet vested at the time of the divorce and you must hold them for more time before exercising.
Stock options, as valuable forms of “alternative compensation”, usually take one of two forms. This can be seen when people are willing to take lower cash forms of compensation in exchange for more remuneration in the way of these stock options.
In the event of an unforeseen divorce, courts usually must first determine what portion of the stock options was actually earned during the marriage. This could be somewhat complex because there are two forms of stock options: One is given as an incentive to work hard in the future and another as “thanks” for hard work done in the past. So it may be difficult at first to determine which type that the option is and therefore how much of the stock option is considered “marital property”. The courts may award completely opposite rulings based on their view of forward or backward looking options.
Courts will take the following into consideration when trying to determine how much of the options were marital property:
Were the stock options offered as a bonus or as an alternative to a fixed salary?
Where either the value or the quantity of the stock options tied to future performance?
Was the stock option plan used to attract key personnel from other companies?
What did the stock option contract specify with respect to the reason for the granting of the stock options?
Usually the answer to the marital property issue will conclude that part of the stock option was for work during marriage and part after getting married (or before). Some formula will be applied.
Then the courts must decide what the value of the option is! They may start by subtracting the strike price from the current trading price. But then the stock price could jump higher or lower at any point so this in itself may not be reliable. The most complicated formula used is the “Black-Scholes” formula which takes in to account the value and market price of the underlying stock, the exercise price of to options, the volatility of the underlying stock, and the amount of time left before the expiration date, and the current interest rates.
As if that were not complex enough the actual dividing of the stock options can also be a challenge. The "Option Holding spouse" may buy out the other spouse’s share of the options but this holder could end up overpaying or underpaying because the price of stock could change at any time.
Therefore, another method is for the holder to divide the options themselves and then the two of them agree that at anytime after divorce the ex-spouse provides the holder with the funds necessary to buy or sell the stock at issue. The downside to this solution is that in this scenario the holder of option is liable for all of the taxes at exercise since stock options are typically nontransferable and nonassignable.
As Nihara Choudhri states in the book,” What to Do Before “I Do” if you or your spouse-to-be is likely to receive any appreciable amount of stock options during your marriage, you would be wise to enter into a prenuptial agreement or in my opinion a Shared Covenant Agreement to specify how those options will be treated in the event of a divorce. Doing so will save you a great deal in the way of time, hassle, and lawyers fees if the day ever comes when you and your souse decide to go your separate ways.
Professional Licenses and Degrees
There is a small possibility—yet it is still a real possibility—that a divorce court could consider your professional license or degree as “marital property”. If so, then it would be subject to division. Though a license or degree can not be sold for profit or handed over to anyone else, the state of New York (only state up to the year 2004) determined that it is still marital property subject to division.
When you think about it, a license or degree could be the most valuable asset acquired during the marriage! Let’s say that your spouse put you through pre-med school and then into your advanced surgical training. Now that you are a successful surgeon with a hypothetical $775,000 per year of earnings in your early thirties you have a present value might be several million dollars to the divorce courts of New York.
Though New York is the only state that views your professional license or degree this way at this time, other states might award a settlement after a spouse who funds license or degree is then left empty handed after a divorce. This is true even though the ex-spouse is perfectly capable of supporting themselves through their own career. This type of spousal support is often known as “reimbursement alimony.”
Again be sure to work with the qualified trust and estate attorney in your state because other states might simply reimburse the supportive spouse for the amount of actual out-of-pocket costs he or she incurred to support the now big wage earner.
Since the laws around this issue of professional licenses or degrees continues to evolve, the fact that New York state has looked at it this way may be a good reason to have a Shared Covenant Agreement drafted which specifies how a license or degree would be handled in the event of a divorce. Especially if you are “the supporting spouse” my recommendation is that you consider looking into the value of having a Shared Covenant Agreement before entering into your relationship.
Closely held corporations and other businesses
Businesses of any kind that are built during a marriage are generally considered marital property in the event of the unplanned for and unforeseen divorce. Even businesses or closely held corporations that are invested into before marriage have often increased in values that will also usually be deemed to be marital property.
Businesses and shares of closely held corporations are challenging to value and to divide in a divorce. Often a couple jointly owns a family business and if it is not equally owned in joint tenancy then typically the spouse most involved in the business (and who holds shares of closely held corporations) buys out the other spouse’s interest in it. However this often involves the costly and long drawn out process of having the business valued using expert analysis of appraisers, and financial professionals. Several valuation methods are employed which may end in a wide range of valuation figures by the professionals employed by both spouses. One such method is the capitalization of earnings method where the businesses and shares of closely held corporations are given a multiply of earnings somewhere between one and four times net earnings to arrive at a dollar value.
The end result is that either you or your ex- spouse now owns or expects to invest in a business or closely held corporations. Was this reality with the entire myriad of financial outcomes discussed prior to remarriage? Having a Shared Covenant Agreement that carefully outlines the business owner’s wishes can be a very smart idea for the good of all involved.
Be aware that the goodwill or reputation value of your professional private practice could be subject to division in the even the marriage does not last as expected.
In these situations, the only asset of any real value is the practice’s reputation and prestige. Though the practice might have a very low business valuation using traditional methods of valuation there are other ways to value in these cases.
Yes, you can’t deposit in a bank your reputation but the goodwill value of the business ensures that the business will be profitable in the future.
Depending on the unique facts in each case and the state in which you live, the goodwill value of your professional practice may or may not be considered marital property. One method commonly used is the capitalization of excess earnings method. The earnings of your practice are compared to the earnings of an average professional in your field and geographical area, with experience, expertise, and education similar to your own. The difference in your earnings and the average earnings of a comparable professional is called your “excess earnings” and is then multiplied by a capitalization factor to arrive at a value for your professional goodwill. Therefore, it might be your best interest to consider a prenuptial agreement which outlines exactly how your professional goodwill is to be handled in the even of a divorce.
It is a mistake to think that a common “buy-sell agreement” will be enough which sets for the value for your practices’ professional goodwill. The courts do not “automatically accept the goodwill values set forth in partnership agreements when making decisions in a divorce. Your partnership agreement might provide that your practices’ goodwill is worth zero, for example, so the partnership will have to pay as little as possible if one partner decided to leave the practice. A divorce court, however, might still decide that your practices’ goodwill is worth several hundred thousand dollars, despite the provisions of your partnership agreement.
Spouses have certain automatic rights to one another’s estates. Thus your business assets might end up distributed completely different than your intentions without a Shared Covenant Agreement in place.
One alternative is to just have an attorney draft a trust and use it as a financial tool that may get some of the desired results. Keep in mind that this trust work will not address all of the non financial aspects of remarried life that the Shared Covenant Agreement does address. But what is the Qualified Terminable Interest Trust or QTIP? Often individuals have two goals when planning for a remarriage with children. One goal is to provide for your new spouse and the other to make sure that your children from the first marriage receive the inheritance intended. This ensures that your assets do not pass along to any future spouse of your husband or wife.
A Qualified Terminable Interest Trusts (QTIP) is an increasingly popular choice in these cases. Here is why: It allows you to leave your assets to your surviving spouse for the duration of his or her lifetime. Then when your surviving spouse dies, the assets in the QTIP get passed on to your children, grandchildren or charity. It allows you to control your assets from your grave! Your current spouse can have access to all of the income from the QTIP and your children are provided for. Moreover, the QTIP allows your spouse the “unlimited marital deduction” so that the inheritance is exempt from estate taxes.
Make sure that you find and work with a qualified trust and estate lawyer about whether the QTIP is appropriate in your case. There may be yet other ways to gift now and restructure your estate to achieve all of your estate goals.
When to Start Planning
Do not wait for engagement to begin planning whether to utilize a QTIP or Shared Covenant Agreement. Waiting too long to bring up emotionally laden issues like inheritances or estate legacies may open the door for tension and problems later. Consider these discussions part of your decision whether to marry. Once both of you are satisfied with your financial plans, you will feel a greater confidence in your decision to marry.
Together with your partner and a Christian trust and estate lawyer you will want to discuss:
- How the Agreement affects all of your current and future property rights as well as those of your children and grandchildren from all marriages.
- If the Agreement considers career sacrifices you may make during the marriage.
- Agreements on college funding for his, hers, and “theirs” children. Who will be paying what amounts or percentages of the college bill? Is our philosophy the same for all of the children? What about advanced degrees? Keep in mind that all spouses including ex-spouses have assets and income that will be looked at for the FAFSA when college aid applications are made.
- How to handle the support of elderly parents and other family issues involving long term care.
- Specific guidelines on roles in the budgeting, asset management, and debt management for each spouse. Should accounts be joint, separate, and if so what amounts or percentages?
- All current estate planning documents, their purpose, and who to contact (phone numbers, addresses of all key financial advisor team members, etc.) regarding each.
- All business planning documents like the buy-sell agreement. Include in simple terms the intentions of owner-spouse.
- Issues such as living wills, final illnesses, burial arrangements, and memorial services.
How Much Does a Shared Covenant Agreement Cost?
The costs to establish a Shared Covenant Agreement vary and could run between a few hundred dollars or a few thousand depending how complex your situation and what area of the country you reside. I recommend first spending some time with your spouse-to-be coming to some foundational agreements before stepping into the attorney’s office. This could save you some time and money in the end.
In conclusion there are many benefits to using the advice of a qualified trust and estate attorney in your state who shares your Christian values in determining whether a Shared Covenant Agreement is a good idea for your remarriage.
Greg Pettys is a Christian author and speaker with ASPIRE GROUP, INC based out of Springfield, IL. Learn more by visiting ASPIRE GROUP, INC’s website at www.gregpettys.com.
“What to Do Before “I Do”’ by Nihara Choudhri, Sphinx Publishing, 2004. Chapter Two: For Better, For Worse, Until Divorce do us Part (Page 60-65).
“Prenups are for Lovers- a romantic guide to prenuptial agreements” Arlene G. Dubin, Random House, 2001.