Trusts and Divorce
Trusts are an important tool that families can use to protect assets and pass wealth to future generations. When the beneficiary of a trust is facing divorce, he or she will be concerned that the trust assets and income may be vulnerable to a spousal claim. Such a claim can include equitable division of property, spousal or child support, and an award of legal fees and costs.
Whether and to what extent a beneficiary’s interest in a trust can be subject to a spousal claim at divorce depends on:
Whether the trust is revocable or irrevocable;
Whether the divorcing spouse is the settlor (i.e., the creator) of the trust, or whether a third party established the trust;
Whether the spouse-settlor funded the trust with marital or nonmarital property, or some of each;
Whether the spouse has the power to compel distributions of trust assets or income;
Whether there is a history of distributions from the trust to the beneficiary-spouse; and
How the spouse used trust distributions after receipt.
Trusts in Property Division
Divorcing spouse as settlor of a revocable trust. If a spouse created and funded a revocable trust before marriage, and contributed no marital property after the parties’ marriage, the trust assets are his or her nonmarital property; nonmarital property is not divisible at divorce.
Courts treat assets in a revocable trust as if they are owned outright by the trust settlor. If the spouse created the revocable trust during the marriage with marital property, such as savings from employment, the assets are marital property and can be equitably divided as if owned outright.
Where a spouse-settlor funds his or her revocable trust with both marital and nonmarital property, the beneficiary’s ability to claim the nonmarital portion depends on whether he or she can clearly prove the identity of his or her nonmarital property contributions. If the assets are completely commingled and have become untraceable, the court may treat the entire trust as divisible marital property.
Revocable trust established by a third party. A divorcing spouse who is the remainder beneficiary of a revocable trust created by a third party, such as a parent or grandparent, has no property right in the trust assets. The third party-settlor is the owner of the assets; they do not belong to the divorcing spouse and are not included in the pool of divisible marital property.
Divorcing spouse as settlor of irrevocable trust. As a rule, a settlor has no power to terminate an irrevocable trust. After the settlor transfers marital (or nonmarital) property to the irrevocable trust, the trust is the owner of the property. Our courts have not wrestled with the question of their power to treat marital assets in an irrevocable trust as divisible property nor how a court can enforce an award against the trust itself. Courts in other states have ruled that a divorce court has power over an irrevocable trust only if the trust is a party to the lawsuit. A spouse who wants a court to take an action that directly affects the trust must sue the trust as an additional defendant in the divorce suit.
Irrevocable trust established by a third party. Like the assets of a revocable third-party trust, the assets of an irrevocable third-party trust are not marital property. A spouse who is the beneficiary of such a trust does not have property rights in the trust assets that a court can divide at divorce. However, under some circumstances, a court can consider the value of the trust in deciding division of the couple’s marital property. One of the criteria for deciding what is a fair division of marital property is the value of each party’s nonmarital property. Where one spouse has substantial wealth in a third-party trust, a judge could decide to award the other spouse more of the marital property.
The Fate of Trust Distributions
Actions a divorcing spouse takes after receiving distributions from a trust may affect division of property at divorce.
Spouse uses trust funds to purchase a home. A spouse who uses trust distributions to purchase a jointly titled family home has created a marital asset that a court will often decide should be divided equally at divorce. The beneficiary-spouse may ask the court for an unequal property award to compensate him or her for the contribution and the judge may or may not agree.
Spouse commingles trust distributions with marital money in an operating account. A trust beneficiary might deposit trust distributions into a bank account in his or her sole name that includes marital funds, such as paychecks. If the owner uses it as an operating account, there may be multiple transactions in and out of the account; the multitude of transactions will make it difficult to clearly establish the portion of the account that is nonmarital property, especially when some contributions into the account were consumed by payment of family expenses. The court may treat the entire account as marital property. In most cases the beneficiary-spouse should not expect a court to compensate him or her for voluntary contributions of nonmarital money that were combined with marital funds and used to enhance the lifestyle of the parties and their children.
Spouse transfers trust funds into a securities account. A spouse who combines trust money and marital money in an investment account titled in his or her name will have an easier time proving the nonmarital contribution as there are likely to be fewer transactions. However, in order to prove the value of the nonmarital share (including the original nonmarital contributions and the dividends, interest, appreciation, and shares acquired through sales and reinvestment) he or she must be able to produce account statements and other documents that show the source of all nonmarital contributions to the account and the entire history of the account from the date of marriage to the date of divorce.
Spouse combines trust distributions with marital money in a joint cash or securities account. A joint account, even one that contains only one party’s trust distributions, could be wholly marital property or part marital and part nonmarital property. A party who seeks to claim a portion as nonmarital must be able to prove it with documents. However, documents showing the source of funds may not be enough; the other spouse may argue the funds or securities were converted to marital property when they were jointly titled. The outcome of such a dispute is unpredictable.
Trusts and Post-Divorce Obligations
When making an award of spousal or child support, courts consider all financial resources available to each party, not just income from employment; the laws governing spousal and child support make no distinction between monies available from wages and monies from a nonmarital source, such as a third-party trust.
The court may consider a history of distributions from a trust, whether a beneficiary is a trustee of his or her own trust, and whether or not the terms of the trust permit the beneficiary to take distributions at will or to require the trustee to make distributions. The court may consider the family’s lifestyle prior to separation in deciding spousal and child support and the extent to which the wealthy spouse used trust assets to enhance the lifestyle. By contrast, if the re is no history of distributions from the trust, the court may ignore the trust in determining support and not speculate about what may happen in the future.
When a spouse has a history of receiving distributions, but they are suddenly cut off when the couple separates, a court may look back several years, average the distributions and set support as if distributions will resume after divorce based on the average.