Are Your Trust Assets Protected From Your Beneficiary’s Divorce?

Leaving a legacy behind for your beneficiaries is a common way to help support them after your passing. Yet this support can be jeopardized if you fail to take the appropriate precautions. Assets bequeathed to beneficiaries may be subject to creditors and, in the case of a divorce, could be vulnerable to equitable distribution. 

Trusts are often used to mitigate some of the risks, but they aren’t a cure-all for protecting assets. In some cases, assets placed in trust may still be at risk during a divorce. 

Establishing a secure legacy for your beneficiaries is important, and there are steps you can take to ensure that assets won’t be compromised if one of your beneficiaries dissolves their marriage. 

In this article, we’ll look at:

• Protections provided by trusts
• Steps to safeguard trust assets
• The role of prenuptial agreements

Vulnerability of trust assets in divorce proceedings

In some situations, trusts can protect assets from being accessed by your beneficiary’s ex during a divorce. However, trusts created for estate planning purposes don’t always include the specific language necessary to protect your beneficiary’s interest in the trust. 

When courts seek to determine if trust assets are marital property, they analyze how distributions from the trust were used in the past and the beneficiary’s interest in the trust.

Key factors in determining trust asset vulnerability

When determining whether a trust will protect assets in a divorce, the court reviews several aspects of the trust. 

Key factors in determining trust asset vulnerability include:

• The terms of the trust
• The type of trust agreement in question
• The beneficiary’s interest in trust income and assets
• Any history of trust distributions
  

The Supreme Court of New Jersey has commonly ruled that if a spouse has not received assets from a trust, the spouse’s interest in the trust as a beneficiary does not count as marital assets. However, suppose the terms of the trust establish that there are assets available for the use and enjoyment of the spouse. In that case, a court may include their interest when determining equitable distribution of marital assets.

A key to determining whether assets are protected in a divorce is whether the spouse has access to the assets. If so, the interest may not be protected. Therefore, when you set up a trust, you must pay close attention to the wording used in the trust agreement. 

How to safeguard trust assets from beneficiary divorce

Asset protection trusts set up by parents and grandparents must be carefully reviewed to ensure they protect a beneficiary’s interest from creditors and spouses.  

When writing the trust:

• Ensure the trust is written to prevent the beneficiary from having immediate rights to the funds. Include spendthrift language in the trust that prohibits a beneficiary from assigning the principal or future income from the trust.
• Articulate that trust funds should only be used for the beneficiary’s health, education, maintenance, and support. 
• Consider indirect distributions of assets, avoiding language that specifies absolute payment requirements. This gives you more control in deciding how assets are distributed. 
• Expand the trustee’s power so they can change the trust as needed if assets are threatened. This might include removing beneficiaries from the trust or moving assets to a different trust. 

Choose the right type of trust:

• Avoid support and income trusts that give beneficiaries mandatory distribution rights. 
• Use a lifetime support trust that names an independent trustee so the beneficiary does not have the right to compel distribution from the trust.

Get the right support:

• Always consult an experienced attorney when drafting a trust to ensure the trust meets the requirements to protect trust assets from a beneficiary’s spouse and creditors.
• Don’t rely on New Jersey trust laws alone to protect a beneficiary’s interest from a divorce. Laws could change in the future.

Types of trusts and their impact on divorce settlements

There are a multitude of different trust options. Depending on your family’s unique situation, some may be more suitable than others. Work closely with an experienced attorney to identify what legal strategy will provide the best protection possible for your legacy. 

Domestic asset protection trusts (DAPT)

When spouses want to protect assets from a divorcing spouse, they may use a domestic asset protection trust (DAPT). They create an irrevocable trust to transfer assets into a separate entity to protect assets from creditors. A third-party trustee has independent power and discretion to make distributions to beneficiaries. The settlor can be the beneficiary of the trust,  but they can also name their spouse and children as beneficiaries. 

A spouse who moves premarital property into an asset protection trust before marriage can prevent the property from becoming a martial asset for property division. The trust must be created before the marriage to protect the assets in a divorce.

However, the assets protected in a DAPT could also include assets for other beneficiaries. If parents create a DAPT naming their children as beneficiaries, the assets should be protected from their children’s spouses during a divorce. 

Revocable trusts

Revocable trusts are a common strategy for estate planning, and they have distinct pros and cons. 

One of the main benefits of a revocable trust is that it can be changed at any time by the settlor. Therefore, the trust could be revoked, and the beneficiary may not receive anything. For instance, if your grandchild is in a tumultuous marriage and there are concerns about how assets might be managed, you have the option to remove them from the trust.  

However, typically, revocable trusts do not protect assets from creditors, which could be an issue if spouses have joint debts that might need to be resolved during a divorce. 

Dynasty trusts

A dynasty trust is another type of trust that can be useful to protect trust assets from ex-spouses. Dynasty trusts are used to pass assets and wealth from generation to generation. When a dynasty trust is created correctly, the assets in the trust do not belong to a beneficiary. Therefore, they are not included in the marital estate. 

There may be other trust strategies you can use to protect assets in a divorce, which means it’s advisable to work closely with a New Jersey lawyer when setting up trusts. If you’re concerned about how existing trust assets will be treated during a divorce, you may also want to consult an experienced New Jersey divorce lawyer. 

Prenuptial agreements and trust asset protection

Prenups can be used in combination with trusts to protect separate property. Disclosing trust interests in a prenuptial agreement can help protect trust assets during a divorce. However, referring to the trust assets as separate property may be a mistake.

By admitting that the property is separate property, the spouse may be admitting that they have a property interest in the trust. Therefore, there could be a claim for appreciation. If the trust isn’t property, there would be no claim.

Instead of stating that the trust is separate property, it may be better to acknowledge the trust in the prenuptial agreement as a discretionary trust interest instead of a property interest. However, each trust and each family relationship is unique, so it’s important to seek experienced legal counsel for prenuptial agreements and executing trusts. 

Consult with an experienced New Jersey estate planning lawyer 

Contact Dughi, Hewit & Domalewski for more information about protecting assets during a divorce through effective estate planning. Our New Jersey divorce lawyers and estate planning attorneys can help you develop an estate plan that protects your assets and meets your goals.