How Are Trusts Treated in the Context of Divorce?

A well-crafted estate plan will generally include one or more trusts.  A trust is often used to provide for the donor during the donor’s life and for the donor’s family after the donor’s death.  Trusts, in addition to providing for the disposition and management of property, may also provide creditor protection for the beneficiaries.  Many clients have concerns about whether a trust will protect assets from a beneficiary’s spouse in the event of divorce.  This discussion assumes the trust was created by a third party and is irrevocable.

Most trusts include a spendthrift clause, which prohibits a beneficiary from assigning his or her beneficial interest in the trust and prohibits a creditor from attaching a beneficiary’s interest.  While spendthrift clauses are generally effective in blocking a beneficiary’s creditor from attaching the beneficiary’s interest, a spendthrift clause may not fully shelter a beneficiary’s beneficial interest in a divorce.  While a spendthrift clause may prevent a beneficiary’s spouse from attaching the beneficiary’s interest or forcing a distribution,  it may not prevent a court from considering the trust in a division of marital assets.  If a trust is considered part of the beneficiary’s property in a division of marital assets, then the marital property being allocated to the former spouse will be adjusted to reflect the fact that the trust is considered the beneficiary’s property.

For example, Massachusetts courts may consider the beneficiary’s trust interest in the equitable division of the marital property.  Much depends on the terms of the trust:  does the beneficiary have a mandatory right to income from the trust?  Does the beneficiary have the right to withdraw property from the trust?  Does the trust permit distribution of principal for the beneficiary’s support and maintenance?  Does the trust grant the trustee sole and uncontrolled discretion to distribute income or principal, or both, to the beneficiary?  Are there other beneficiaries of the trust?  Has the beneficiary regularly received distributions of principal and have distributions from the trust augmented the couple’s income and lifestyle?  Alternatively, is the beneficiary’s interest more in the nature of an expectancy?  A court will employ this type of facts and circumstances analysis to determine whether the beneficiary has an enforceable property right or an indefinite right.

Other jurisdictions take a different approach.  Nevada and South Dakota provide by statute that a beneficiary’s interest in a trust is not subject to the claims of the beneficiary’s spouse in a divorce.  In New York, an irrevocable trust is considered separate property and not included in the division of the marital estate.  However, a court may consider the trust in determining the beneficiary’s obligation to pay maintenance and child support.

In California, which is a community property state, a beneficiary’s interest in a trust created by a third party is considered separate property and not subject to division in a divorce proceeding.  However, while the trust is considered separate property and not subject to division, the California Probate Code provides if the trustee decides to make discretionary distributions to a beneficiary, the court may order the trustee to make payments from those distributions to satisfy a beneficiary’s obligation to pay support to a spouse, former spouse or minor child, even if the trust includes a spendthrift provision.  Further, if the court finds the trustee is acting in bad faith in not making a discretionary distribution to satisfy an outstanding support order, the court may order the trustee directly to make a distribution to satisfy the support obligation.

Finally, the Uniform Trust Code provides that a spendthrift provision is unenforceable against a beneficiary’s child, spouse or former spouse who has a judgment or court order against the beneficiary for support or maintenance.  The beneficiary’s child, spouse or former spouse may obtain a court order attaching present or future distributions to or for the benefit of the beneficiary.  Further, the Uniform Trust Code provides that where the terms of the trust permit a distribution for the beneficiary’s support and maintenance and the court determines that the trustee has failed to comply with this standard, then the court may order that distributions be made from the trust to satisfy the beneficiary’s obligations under a judgment or court order to pay support and maintenance of the beneficiary’s child, spouse or former spouse.  Many states enacting the UTC have included this provision; however, some states, including Massachusetts, have not adopted this provision.

Conclusion

In divorce proceedings, the treatment of a beneficiary’s interest in a trust varies from state to state.  Therefore, each state’s common and statutory law needs to be considered in determining whether a trust is considered marital property in a divorce proceeding or whether a spendthrift clause in the trust will prevent a former spouse from reaching the beneficiary’s interest.  Short of a prenuptial agreement which provides that beneficial interests in a trust are not to be taken into account by a court in dividing marital property or awarding support, trusts which grant the trustee absolute and uncontrolled discretion to distribute income or principal to a beneficiary provide the best protection in the event of the beneficiary’s divorce.  In states like Massachusetts which provide for a broad definition of marital property for the purposes of an equitable division of assets between divorcing spouses, whether a trust is considered marital property is a facts and circumstances analysis.