Divorce typically involves dividing marital property between spouses, and this process can significantly reduce the wealth either party retains. An irrevocable trust, properly structured and established at the right time, may protect certain assets from being classified as marital property subject to division. Understanding how courts treat irrevocable trusts in divorce settlement proceedings helps in evaluating whether trust planning makes sense for asset protection purposes.
Marital Property vs. Separate Property
Before examining how trusts affect divorce, it helps to understand the basic framework courts use to divide assets.
Marital property generally includes assets acquired during the marriage, regardless of whose name is on the title. Income earned during the marriage, assets purchased with that income, and appreciation on marital assets typically fall into this category. Marital property is subject to division in a divorce, with most states following equitable distribution principles that divide property fairly, though not necessarily equally.
Separate property includes assets owned before the marriage, inheritances received by one spouse, and gifts made specifically to one spouse. Separate property typically remains with the spouse who owns it and is not divided in the divorce. However, separate property can become marital property through commingling, such as depositing an inheritance into a joint account, or through actions that transmute the character of the property.
The categorization of assets as marital or separate significantly affects the divorce outcome. Keeping separate property clearly separated from marital assets is essential to preserving its character.
How Irrevocable Trusts Provide Protection
An irrevocable trust removes assets from the grantor’s ownership. Once assets are transferred to an irrevocable trust, the grantor no longer owns them. The trust is a separate legal entity, and the trustee holds legal title to the assets for the benefit of the beneficiaries.
Because the grantor no longer owns assets in an irrevocable trust, those assets are generally not considered marital property subject to division. The trust is treated as a third party, and courts typically cannot divide property owned by third parties in a divorce proceeding.
This protection is strongest when the trust was created before the marriage with assets that were separate property at the time of transfer. In this scenario, the assets never belonged to the marital estate. They were transferred to the trust before the marriage began, and the trust held them throughout.
The protection may also apply when a trust is created during the marriage using separate property, such as inherited assets or gifts from third parties. If the assets being transferred to the trust were never marital property, the trust simply continues their separate character.
Factors Courts Consider
While irrevocable trusts can protect assets in divorce, courts examine several factors before respecting the trust’s protection.
Timing of trust creation matters significantly. A trust created years before a marriage or any contemplation of divorce is much more likely to be respected than one created shortly before or during divorce proceedings. Courts are suspicious of transfers made in anticipation of divorce and may find them to be fraudulent attempts to hide marital assets.
Source of trust funding affects the analysis. Assets that were clearly separate property before transfer to the trust receive stronger protection than assets with unclear origins. If marital funds were used to fund or augment the trust, the spouse who did not create the trust may have a claim to a portion of the trust assets.
Terms of the trust influence outcomes. A fully discretionary trust where the trustee has complete control over distributions is more protective than a trust that requires distributions to the beneficiary spouse. When a spouse has guaranteed access to trust assets, courts may count those assets when determining property division even if they technically remain in trust.
Grantor’s control is scrutinized. If the grantor retained significant control over the trust despite calling it irrevocable, courts may disregard the trust form and treat the assets as belonging to the grantor. This is similar to the alter ego analysis used in creditor cases.
State law variations affect outcomes. Some states provide more protection for trust assets than others. States that have adopted domestic asset protection trust statutes may offer specific protections against divorce claims that other states do not provide.
Self-Settled Asset Protection Trusts
In states that permit domestic asset protection trusts, a spouse can create an irrevocable trust for their own benefit and potentially protect those assets from a divorcing spouse.
Wyoming’s qualified spendthrift trust statute provides that exception creditors for child support claims include only claims that existed before the transfer to the trust. Alimony and property division claims are not specifically listed as exception creditors under Wyoming law, meaning assets properly transferred to a Wyoming DAPT before divorce may have some protection.
South Dakota similarly limits exception creditors. Child support and alimony claims are exception creditors only if the support order existed at the time of transfer. A divorcing spouse can reach trust assets only if the transfer was made during the marriage using marital property and the spouse was not given proper notice.
Nevada’s statute provides that no exception creditors exist, potentially offering the strongest protection against divorce claims.
However, creating a self-settled trust specifically to prevent a spouse from receiving assets in an anticipated divorce creates significant legal and ethical issues. Courts finding fraudulent intent can set aside the trust, impose sanctions, or adjust the property division to account for the hidden assets. The timing and circumstances of trust creation are critical.
Third-Party Trusts in Divorce
Assets held in trusts created by someone other than the spouse, such as trusts established by parents or grandparents, receive different treatment in divorce.
When a spouse is a beneficiary of a trust created by a third party, the trust assets generally remain separate from the marital estate. The beneficiary spouse does not own the trust assets and cannot control whether distributions are made. Courts typically cannot order a third-party trustee to make distributions to satisfy a divorce judgment.
However, courts may consider the income from such trusts when calculating support obligations. If a spouse receives regular distributions from a family trust, those distributions may be counted as income for child support or alimony calculations even though the trust principal remains protected.
In the Massachusetts case Pfannenstiehl v. Pfannenstiehl (2015), the court considered whether the assets of a discretionary trust created by the husband’s father could be included in the marital estate. The case raised concerns about how aggressively courts might reach into third-party trusts, though the specific facts involved substantial historical distributions to the beneficiary.
Parents and grandparents concerned about protecting gifts and inheritances for their children and grandchildren should consider holding those assets in properly structured trusts rather than making outright transfers.
Planning Considerations
Several factors should guide the decision to use an irrevocable trust for divorce protection.
Create trusts well in advance. The best time to establish an irrevocable trust is before marriage or during a stable period in the marriage when divorce is not contemplated. Trusts created in anticipation of divorce are much more likely to be challenged successfully.
Use clearly separate property. Fund the trust only with assets that are unquestionably separate property: pre-marital assets, inheritances clearly received by one spouse, or gifts from family members to one spouse specifically.
Choose an independent trustee. Having a trustee who is not the grantor or the grantor’s spouse strengthens the argument that the trust is a genuine separate entity. The trustee should exercise true discretion over distributions.
Make the trust fully discretionary. A trust that requires distributions or gives the beneficiary enforceable rights to assets is more vulnerable than one where the trustee has complete discretion over if, when, and how much to distribute.
Consider prenuptial or postnuptial agreements. A prenuptial agreement can specify that trust assets and any future distributions are separate property, reducing the chances of a court challenge. The agreement can work in conjunction with trust planning.
Document the separate character of trust assets. Maintain clear records showing that the trust was funded with separate property and that marital assets were never commingled with trust assets.
Limitations and Risks
Irrevocable trusts are not guaranteed protection against divorce claims.
Courts have broad equitable powers in divorce proceedings. If a court believes the trust was created to defraud a spouse or to hide assets improperly, it may set aside the trust, include its value in the marital estate, or adjust the division of other assets to compensate.
The spouse who did not create the trust may challenge its validity or argue that they have rights to the assets based on theories of constructive fraud, undue influence, or unjust enrichment.
Even if trust assets are protected from division, they may be considered for support calculations. A spouse receiving substantial income from a trust may face higher support obligations as a result.
Professional guidance is essential. Creating an irrevocable trust for divorce protection involves complex legal issues that vary by state. Working with experienced estate planning and family law attorneys helps ensure the structure is effective and does not create unintended consequences.
Conclusion
An irrevocable trust in divorce settlement can protect assets from division as marital property when the trust is properly structured, created at an appropriate time, and funded with clearly separate property. Courts examine timing, funding source, trust terms, and grantor control in determining whether to respect the trust’s protection. Self-settled asset protection trusts in states like Wyoming, Nevada, and South Dakota may offer additional protection, though the circumstances of creation remain important.
For guidance on irrevocable trust planning for asset protection purposes, consider consulting Mark Pierce and Matt Meuli at Wyoming Trust Attorney.