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When Assets Are Tied up in Trusts

This article was written by Hance Law Group principal Larry Hance.

Many high net worth divorces involve assets contained within a trust or trusts. One that I’m working with right now involves an issue that can certainly come up in this type of divorce — when a significant percentage of a couple’s assets are tied up in trusts.

There are some very sound legal reasons to create trusts, and a great number of high net worth families use them. The three primary reasons are:

  1. Protection from lawsuits and creditors (especially for people in occupations more susceptible to lawsuits, like doctors, lawyers, and CEOs)
  2. To create a legacy
  3. Potential tax benefits

When a trust is created, as long as it’s done legally, that money is no longer part of the marital estate. In a great number of situations, that can certainly benefit a married couple. But in a divorce, can create some very complex issues–especially if the trust was created or funded in anticipation of filing for divorce.

If a trust was created or funded near the time of the divorce, that’s an obvious red flag, but even trusts created early in the marriage, with both spouses agreeing to the terms of the trust, might require more scrutiny than they might initially appear to need.

To fully understand the parameters of a trust, it’s necessary to know who the trustee is, who the beneficiaries are, and how the distribution rules operate.

For example, if the trustee is a close personal friend of the husband rather than a bank, that could make a difference in how the trust operates.A trust might be set up to provide the wife in this situation with a certain amount of income. After the divorce, the husband and trustee couldn’t change how much income is distributed to the now-ex-wife via the trust, but they could conceivably change how much income the trust produces, by investing the assets differently.

Both spouses, even though they’re signing off on a trust, might not be aware of the pitfalls embedded in trusts, that reveal themselves once divorce happens and parties who were allies become adversaries. There’s actually a debate in the estate planning community right now around these issues. Most trusts are set up by one lawyer acting in the interest of both parties. The lawyer would normally have no idea that one party might be seeking trust in order to control assets after an impending divorce. In my opinion, any time marital assets are transferred to a trust, or family limited partnership (or similar entity), each party should have a lawyer. And these lawyers should advise both spouses on the effect of this transfer of assets on them if they were to divorce.

Since it’s difficult to change the terms of the trust after, a divorce, it’s best to address any of the assets in a trust while divorcing negotiations are in process. In some cases, the rules and circumstances around trust are so complex that it’s better to just dissolve a trust and disperse the assets to the spouse directly, or as part of the total community property division. And while it is possible to convince a judge to ignore a trust under some circumstances when dividing marital assets, it’s very difficult to do and should be a last resort.

Sound legal advice from a family lawyer knowledgeable in trusts is essential in these cases, whether you’re a high net worth earner trying to protect his or her wealth through trusts, or the spouse of a high net worth earner trying to ensure a fair divorce settlement.