May 5, 2021
Trusts and Divorce
One of the frequently mentioned benefits of a trust is to protect the trust’s assets from a beneficiary’s creditor claims. While many trust beneficiaries do not have creditor problems, many of those same trust beneficiaries are married, and nationwide statistics show that about 50% of marriages end in divorce. One question that frequently arises is whether an irrevocable trust that holds title to assets can be protected from confiscation and distribution in the trust beneficiary’s divorce.
Michigan has a very favorable law that provides that if the trust is a wholly discretionary trust, where the trustee possesses the sole discretion to make distributions of trust income or principal to the trust beneficiary without any standards or limitations, then the trust beneficiary is treated as not possessing any property right in the trust. If there is no property interest, then there is nothing for the divorce court to divide. It is only after the trustee makes a distribution from the discretionary trust directly to the trust beneficiary that the trust beneficiary’s creditor, or a former spouse or a divorce judge, can access the distributed assets.
However, not too many irrevocable trusts that are created for a beneficiary, such as a child or grandchild, are a wholly discretionary trust. Often a trust will provide standards or limitations to guide the trustee, such as directing the trustee to make a distribution from the trust for the trust beneficiary’s health, education, support and maintenance. This type of trust is often referred to as a support trust, to be distinguished from a wholly discretionary trust. With a support trust a divorce judge is unable to order any distribution from that trust by the trustee. After a distribution from the support trust to the trust beneficiary the income or principal that are distributed are subject to the enforcement of a judgment, or the control of a divorce judge, but only to the extent that the income, or principal, or both, are not necessary for the trust beneficiary’s health, education, support or maintenance.
While many irrevocable trusts contain a spendthrift provision, which prohibits the trust beneficiary from voluntarily assigning his or her interest in the trust, or the involuntary transfer of the trust beneficiary’s interest in the trust, e.g. a judgment creditor attempts to seize assets held in the trust to satisfy their judgement, such as by a divorce judge’s order, there are limits to the protection provided to the beneficiary’s interest in a spendthrift trust. Michigan’s statutes permit an enforceable claim against a trust beneficiary’s interest in an irrevocable spendthrift trust if the trust beneficiary’s child or former spouse has a judgement or court order for financial support or maintenance. Yet the trust’s assets cannot be invaded or accelerated to satisfy a child support or spousal support obligation until after a distribution of trust income or principal becomes due. However, if the irrevocable trust is a wholly discretionary trust for the trust beneficiary, then the trust’s assets are unavailable to satisfy the trust beneficiary’s child support or spousal support obligations.
Even if a divorce court cannot access the assets held in the trust established for one of the divorcing parties, many divorce judges will still consider the value of the trust’s assets in dividing the trust beneficiary’s marital estate. Consequently, while the trust’s assets are not taken as part of the divorce court’s division of the marital estate, the trust beneficiary may receive less than their fair share of the marital estate.
There are many other facts that a divorce judge will look at before he or she decides to consider the trust’s assets in fashioning an equitable distribution of the marital estate. As a result, a trust can be structured to prevent a divorce judge from invading the trust’s assets to fashion a divorce settlement. How a trust might be structured to maximize protection for the assets held in trust from the trust beneficiary’s creditors, including a former spouse, include the following:
- SPENDTHRIFT PROVISION: The trust should contain a spendthrift provision that prohibits a voluntary or involuntary transfer of the beneficiary’s interest in the trust. This will prevent the beneficiary’s creditor, or former spouse, from collecting claims directly from the trustee.
- STATEMENT OF SETTLOR’S INTENT: The creator of the trust should add a statement to the trust to the effect that non-beneficiaries possess no rights in the trust, that distributions are available only to the named trust beneficiaries to the exclusion of any other persons, including the beneficiary’s spouse. This statement is important because the settlor’s intent controls any judicial interpretation of the trust instrument.
- MORE THAN ONE TRUST BENEFICIARY: If the trust includes a class of trust beneficiaries in addition the beneficiary in a divorce, or if that class of beneficiaries is left open, e.g. “the trustee may distribute trust income to my son or any of my son’s descendants” it is less likely that the divorce judge will try to reach the trust’s assets or take the trust into consideration when dividing the beneficiary’s marital estate. The trust might start out with a single beneficiary, but if that beneficiary is in a later divorce, a trust director (formerly called trust protector) could step in and amend the trust to add other beneficiaries to the trust, such as the trust beneficiary’s descendants.
- BROAD AND UNFETTERED TRUSTEE DISCRETION: As noted above, if the trust is wholly discretionary then the trust will not be considered an asset or property interest held by the trust beneficiary. However, often there is a mix of words in a trust that can lead to confusing results, e.g. “the trustee shall distribute assets to my son for his support in the trustee’s sole and absolute discretion.” Mixing trust distribution standards like ‘shall distribute’ with ‘sole and absolute discretion’ can lead to confusion and possibly expose the trust’s assets to the beneficiary’s creditors, including a former spouse in a divorce. Additional guidance can be given to the trustee in the exercise of the trustee’s discretion through letters of wishes the trust creator can leave with the trustee, i.e. a non-binding statement of intent.
- INDEPENDENT TRUSTEE: If an independent, disinterested trustee is named, like a corporate trustee, that neutral trustee will remove the appearance of self-dealing or suspicion that the trustee can manipulate trust distributions for the trust beneficiary who is in a divorce. All trustees have a fiduciary duty of impartiality to consider the interests of both the current trust beneficiary (going through the divorce) and the remainder trust beneficiaries, a duty that trustees do not take lightly.
- LACK OF TRUST BENEFICIARY’S CONTROL: The more control the trust beneficiary has over the trust, the more likely it is the divorce judge will take the trust and its assets into consideration in dividing the beneficiary’s marital estate. Areas where a trust beneficiary might have some control include: (i) removing the acting trustee; (ii) removing a trust director, protector, or member of a distribution committee that directs the trustee; (iii) the right to withdraw a portion of the trust assets each year, e.g. a withdrawal right of 5% of the trust assets each year; (iv) the right to receive distributions from the trust on specified events, e.g. when the trust beneficiary attains ages 25, 30 and 35 years; (v) the trust beneficiary holds a testamentary limited power of appointment to redirect the trust assets on that beneficiary’s death. The fewer the rights or control the beneficiary has over the trust, the less likely it is that a divorce judge will look to the trust as a source of the beneficiary’s support or wealth.
- HISTORY OF DISTRIBUTIONS: Some divorce judges will look closely at the history of trust distributions to the trust beneficiary. If there is a pattern or routine for the distributions to the trust beneficiary, especially if the beneficiary’s lifestyle and living expenses were tied to those periodic trust distributions, there is a greater likelihood the divorce judge will factor the presence of the trust’s assets into the divorce’s asset division.
- AUTOMATIC SUSPENSION OF DISTRIBUTIONS: The trustee can be given the power to withhold, in further trust, property that is otherwise subject to an outright distribution to the trust beneficiary who is going through a divorce. For example if the beneficiary possesses a right to withdraw one-third of the trust’s assets upon attaining age 30 years, that right of withdrawal is automatically suspended if the trust beneficiary is then in a divorce.
- SUSPEND ACCOUNTINGS: Under Michigan law a trust beneficiary is entitled to receive periodic accountings from the trustee. If the trust beneficiary is in a divorce, the trustee could be given the authority to change the situs of the trust to another state, like Delaware, where the beneficiary’s right to a trust accounting can be limited or suspended for a period of time. This might be done if the trustee believes that such information with regard to the trust would not be in the trust beneficiary’s interest, or would have to be disclosed in the divorce proceeding.
- SPOUSAL WAIVERS: Some trusts are drafted to require the trust beneficiary’s spouse to waive his or her marital rights each time the beneficiary is eligible to receive a principal distribution- the spouse’s waiver is a precondition before the distribution can be made to the trust beneficiary.
Finally, if there exists a genuine concern that the trust beneficiary will lose trust assets in a future divorce then a Michigan Qualified Dispositions in Trust should be considered. This is Michigan’s version of an asset protection trust. While normally it used by a person who wishes to transfer their own assets to an irrevocable trust and remain a potential trust beneficiary to protect their own transferred assets from creditor claims, such a trust can be set up by a third person, like a parent or grandparent for the trust beneficiary. The importance of a qualified dispositions trust is that Michigan’s enabling statute clearly directs that a divorce judge shall not consider, let alone invade, the irrevocable trust when its beneficiary is going through a divorce.
There is always a strong interplay between estate planning and domestic relations law. Fortunately Michigan has some very favorable statutes that go a long way to protect assets held in a trust if the trust beneficiary is in a divorce. The problem arises when the trust beneficiary lives in another state with less favorable laws when divorce suddenly strikes, which is why how the trust is structured can help to protect the trust’s assets in that divorce.