Using Trusts to Protect Inherited Assets in the Event of Divorce: Strategies to Protect Family Wealth

First Republic Trust Company
September 14, 2020

It’s common knowledge that about half of all marriages end in divorce. More surprising is that, for those who marry more than once, the rate is substantially higher. For individuals and families with considerable wealth, protecting assets in the event of divorce is, understandably, a concern. So, how can families safeguard their wealth? Having children or grandchildren enter into prenuptial agreements is the safest strategy to shield assets in the event of a marital split. That being said, bringing up the future division of assets can be an uncomfortable topic, leading many couples to forego the issue rather than ignite potential strife before walking down the aisle. 

For parents and grandparents who don’t want to dilute family wealth, a trust can help shield assets in the event a child’s or grandchild’s marriage goes south and divorce materializes. Assets left outright to a child or grandchild are reachable by his or her creditors, including a future divorcing spouse. In contrast, assets held in trust may be harder for a divorcing spouse to reach. When establishing a trust, potential protection strategies to consider include the following:

  • Naming a truly independent trustee. An independent trustee is someone with no beneficial interest in a trust. Options usually come down to a professional trustee or a family member, with each having its own benefits. A relative, for example, is likely to understand a family’s dynamics and may be deemed an independent trustee for tax purposes. However, a truly independent trustee is an unrelated third party, such as a corporate trustee. Recent case law suggests that the more control a beneficiary has over trust assets, such as an implied power to direct a family-member trustee, the greater the likelihood that those assets would be deemed be part of the beneficiary’s marital estate. Naming a truly independent, corporate trustee makes this less likely.
  • Including a spendthrift provision. A spendthrift provision prevents a beneficiary from assigning his or her interest and prevents creditors from attaching the interest before it is distributed. This is an essential provision in any trust.
  • Requiring prenuptial agreements for beneficiaries. A trust may provide that no distributions will be made to a married beneficiary unless he or she has a valid pre- or postnuptial agreement. Including such a provision can be an excellent way to start a conversation about prenuptial agreements with a soon-to-be married beneficiary.
  • Using broad discretionary language. Granting an independent trustee broad discretion to distribute income and principal among beneficiaries for any reason and in any amounts the trustee deems appropriate gives the trustee maximum flexibility and limits the likelihood that the trustee or the assets of the trust will be deemed subject to the beneficiary’s control. More restrictive language, while intended to limit the provisions for which distributions can be made, can actually be interpreted as giving a beneficiary the ability to compel distributions and increase the likelihood of the beneficiary’s share of trust assets being included in the marital estate.

It’s important to keep in mind that no trust offers guaranteed protection in the event of a divorce. Trust laws vary by state, as do divorce laws. While a trust may be governed by the laws of one state, a divorcing beneficiary may reside in another state with different marital property laws. Differences in state law can have a significant impact on whether assets in trust are included in a divorcing beneficiary’s marital estate.

When it comes to family finances, a little pre-planning can go a long way toward protecting a family’s wealth. Careful planning to transfer assets to a well-structured trust rather than giving them to a beneficiary outright can help keep trust assets outside the reach of the family court and a divorcing spouse. Of course, in the best case scenario, a couple will live happily ever after, ’til death do them part and will never need to worry about the “marital estate” or a divorcing spouse.

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