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How to Protect Trust Assets From a Beneficiary’s Divorce

SmartAsset: How to protect trust assets from a beneficiary's divorce

Trusts can be a useful estate planning tool for passing on wealth to heirs. When naming beneficiaries, it’s important to consider how their spouses may fit into the picture. Specifically, you may wonder how to protect trust assets from a beneficiary’s divorce should the marriage end. There are some measures you can take to make a trust “divorce-proof.”

Talking to your financial advisor can help you evaluate your options.

How Are Trust Assets Treated In Divorce?

Along with making provisions for the care of children, the division of assets is often a focal point in divorce cases. When one spouse is the beneficiary of a trust, there may be a question of how any assets they’re entitled to inherit should be treated.

The answer typically depends on state law and how the trust is structured. In community property states, for example, trust assets that a beneficiary spouse is entitled to receive can be considered the separate property of that spouse even when a distribution occurs during the marriage.

However, this rule isn’t foolproof. A non-beneficiary spouse could still attempt to claim some of those assets during divorce proceedings. If the court agrees with their argument that they’re entitled to part of the beneficiary spouse’s inheritance, they could walk away with some of the assets from the trust.

A non-beneficiary spouse could also have legal grounds to inherit trust assets if the beneficiary spouse does one of two things:

  • Commingles them with shared assets, making them community or marital property
  • Makes them the separate property of the non-beneficiary spouse

The legalities can get technical, depending on how trust and divorce laws apply in the state where the spouses live. An estate planning attorney and a divorce attorney may be necessary to sort those issues out.

How to Protect Trust Assets From a Beneficiary’s Divorce

SmartAsset: How to protect trust assets from a beneficiary's divorce

If you’re establishing a trust to leave a legacy of wealth for your children or grandchildren, divorce is an important contingency that you may want to plan for. Without stopgaps in place, it’s possible that your wishes for the distribution of trust assets may not go as planned should one or more beneficiaries get divorced.

As a trust grantor, there are several things you can do to shield trust assets from divorce.

1. Choose the Right Wording

If a court is called to examine trust documents in order to determine what assets a beneficiary might receive, the choice of wording used matters. When the trust document makes the distribution of assets seem like a possibility, rather than a certainty, that could cast doubt on when the beneficiary spouse will receive an inheritance, if at all.

In that case, the court may decide to exclude trust assets when dividing property in a divorce if it believes there’s no guarantee that the beneficiary spouse will receive them. An estate planning attorney can assist with choosing the right wording. But it should be clear that named beneficiaries cannot receive assets from the trust on demand.

You can also specify in the trust that nonbeneficiaries are not entitled to receive any assets from the trust. And that’s even if they’re married to a beneficiary. By making your intentions clear, you can reduce the possibility of your wishes being overruled should the trust document come into question during a divorce proceeding.

2. Consider Indirect Distributions of Assets

Indirect distributions are another option you might consider for how to protect trust assets from a beneficiary’s divorce. Rather than distributing assets to the beneficiary directly, you can include provisions in the trust that allow payments to be made on their behalf.

You may also want to avoid any language that specifies absolute requirements for payments. It’s not uncommon for trust grantors to set conditions for the distribution of assets. For example, you might state in the trust document that your oldest child must wait until a certain age to withdraw all of the assets they’re entitled to receive.

Those kinds of provisions give you some predictability and control in deciding when your assets get distributed. However, they can be problematic if they come under scrutiny during a divorce proceeding later. Should the court determine that the distribution of assets is guaranteed, they could become vulnerable to division.

3. Expand the Trustee’s Powers

A trustee’s job is to carry out the trust grantor’s wishes while acting in the best interests of the beneficiaries at all times. That being said, as the trust grantor you have some leeway in deciding what a trustee can do.

For example, you may authorize your trustee or successor trustees to make certain changes to the trust should assets be threatened by a beneficiary’s divorce. You may instruct the trustee to remove a beneficiary from the trust completely if they’re getting divorced or a divorce seems likely. The trustee may also be instructed to shift assets into a new trust for the benefit of a divorcing beneficiary.

Again, it may be helpful to consult with an estate planning attorney, divorce attorney and a financial advisor when deciding what powers to grant a trustee. And it’s also important to consider the potential consequences of removing a beneficiary as a precautionary move against divorce should they decide to continue in the marriage.

4. Make the Trust Irrevocable

Revocable trusts allow you to transfer assets to the control of a trustee and make beneficiary designations. If you change your mind about the trust terms later, you can change them.

Irrevocable trusts don’t work that way. Once assets are transferred to the control of the trustee, the transfer is permanent. It can be exceptionally difficult to change the terms of an irrevocable trust once it’s established and funded.

Making a trust irrevocable can protect a beneficiary in divorce since the terms cannot be altered. An irrevocable trust can’t be dissolved either until its purpose is fulfilled, i.e., passing assets on to beneficiaries.

If you’re certain about the assets that you want to leave to a beneficiary who could potentially get divorced, then you might consider creating an irrevocable trust separately for them. You could then create a second revocable living trust to hold assets that you want to distribute to your other heirs.

Bottom Line

SmartAsset: How to protect trust assets from a beneficiary's divorce

There is no single solution for how to protect trust assets from a beneficiary’s divorce. You may need to weigh the pros and cons of different trust management strategies to decide which ones to implement. Your advisor can offer guidance on the best ways to incorporate a trust into your estate plans. And in turn, you can pass on wealth to future generations with minimal obstacles.

Tips for Estate Planning

  • If you’re ready to develop your own trust, consider enlisting a financial advisor to help. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with three vetted financial advisors who serve your area in five minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
  • Whether you’re just starting retirement or just starting a family, it’s never too soon to start estate planning. One of the first steps to estate planning is creating a will and updating it over time. Consider drafting a will so that your property, assets and family are protected in case of an emergency.

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