In the US, some states are known as community-property states. What is a community property state?
A small handful of state governments view legally married couples as joint owners of almost all assets — bought and earned — as well as any debts incurred since the wedding.
In the case of a divorce, assuming there was no prenup agreement, the couple must split everything evenly between them.
What is a Community-Property State?
In a community-property state, once a couple gets married they become equally responsible for and have equal claim to everything they own.
For example, if you take a loan out in your own name to buy a car that only has your name on the title, your partner still holds 50% of the responsibility. Any property a person acquires before marriage can still be owned individually.
In the US there are nine community-property states:
- New Mexico
The only way to own separate property as a legally married couple in these states is if a prenuptial agreement states otherwise. In the case of a divorce without a prenup, everything is split evenly down the middle no matter what.
These laws can have an huge impact on a couple’s finances. However, keep in mind that while these states share some common features and definitions, there is no one uniform community-property system.
Community-Property States vs Common Law Property States
All other states operate under the same system: common law property. Whether or not a couple is legally married doesn’t define property ownership. If you take a loan out in your name to buy a car and only your name is on the title, you are 100% responsible. The only way that car could belong to both of you is if both names are on the title.
Basic differences between these two systems can be summed up as such:
- In community-property states, married couples are joint owners of most things acquired during the marriage unless stated otherwise in a legal document. After you get married, co-ownership is the default.
- In common law property states, assets acquired by a married individual legally belong to the individual, unless the couple put both of their names on it. Whether you’re married or not, individual ownership is the default.
Community-Property States: Assets Owned Prior to Marriage
Any assets a person owned before joining in matrimony are typically still considered separately owned.
For example, if you own a home before you get married, it’s still only belongs to you after you tie the knot, even in a community-property state. Things can get tricky if you get divorced and don’t have records of what you owned prior to marriage.
Other than assets owned prior to marriage, other property that is considered separate in a community-property state may include:
- Property acquired by gift
- Property acquired by inheritance or bequest from a will
- Property acquired in a court award
Changing Ownership Status in Community-Property States
Most community-property states allow spouses to determine or change the status of their property as community or separate. The legal term for this action is transmutation. There are two important transmutation restrictions:
- Federal law obligations cannot be avoided by transmuting property
- A transmutation that is effective between spouses may not be effective against third parties like creditors
If married couples move from a community-property state to a common-law state, this does not change the status of the marital property acquired in the community-property state unless the couple takes steps to change it.
Overall, if you live in a community-property state, it’s not a bad idea for spouses to keep organized records of their personal financial matters.
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Life Insurance and Community-Property
So, how do community-property laws affect life insurance policies?
Generally, policyowners have a lot of flexibility on who they want to name as their beneficiary. Often, a policyowner will name a spouse as a beneficiary, but not always. They can name an adult child, parent, or even a close friend.
However, if they live in a community-property state and income earned during the marriage is used to pay the premiums then typically the spouse legally has rights to 50% of the death benefit.
Example: John lives in California and has a term life insurance policy in which he designates his mother and father as the beneficiaries. He then marries Jane , but forgets to update the policy.
He unexpectedly dies but because they live in a community-property state and John paid premiums with “jointly owned” income, Jane automatically receives half of the death benefit, with the remaining half going to John’s parents, even though she wasn’t listed on the policy.
When alive, if John wanted to name his parents sole beneficiaries and not have Jane be a beneficiary, Jane would have had to sign a consent form waiving her rights to the death benefit.
This example is not always the case, and permanent life insurance policies can be more complex than term, so it’s important to work with a professional who is knowledgeable about community-property laws.
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