A trust is a legal document that holds assets on behalf of an individual or family. Also known as a living trust, it can be set up to provide for a family's current needs or for the needs of future generations. It’s a great way to protect your assets and make sure they’re used as you intended.
Questions sometimes arise during and after the divorce process regarding trust assets. To whom do they rightfully belong?
To better understand the answer to this question, let’s examine trusts in more detail.
A closer look at trusts
Inheritance Trust
Let’s say an elderly parent wants to make sure their children receive an inheritance without having it go through probate court. To do this, they create a trust with specific instructions about how to divide their assets among their children. This trust also protects the inheritance in the event of a divorce: If one of their kids gets divorced, the money in the trust cannot be divided between them and their former spouse, so long as the trust was not dispersed prior to the divorce. It is considered separate property in this case.
Wealth Preservation Trust
This type of trust is designed to protect your wealth from taxation and creditors by transferring ownership of your assets into the trust instead of leaving them in your name alone. It allows you to maintain control over your assets while avoiding taxes and protecting yourself from creditors’ claims if something happens in your life that requires you to go into debt or declare bankruptcy.
Education Trust
Let’s say a married couple sets up a trust for their children's education expenses. The trust contains money earmarked for educational costs such as tuition, books, and supplies. In the event of the couple’s divorce, the trust would remain intact. However, if the couple had specified that only one parent would be responsible for making decisions about how the money should be used (which school to attend or which courses to take), the court might have to intervene and decide who should make those decisions after the divorce.
What is the primary purpose of a trust?
The primary purpose of establishing a trust is to protect your assets and property from creditors, lawsuits, and other liabilities. The assets held within the trust are managed by the trustee, who is responsible for overseeing how those assets are used and that they are distributed according to your wishes.
Establishing a trust also makes it easier to pass on assets after death since it can help avoid probate court proceedings and court costs associated with probate.
What are the benefits of having a trust?
Having a trust provides numerous benefits for asset protection and estate planning purposes.
- A trust can help you minimize taxes on a large estate by allowing you to transfer assets in smaller increments over time or at specific times in the future.
- A trust can be used to manage family wealth or provide for special needs beneficiaries in perpetuity.
- Because trusts do not have to be filed with public records, having one can help protect privacy.
- You maintain control over your assets even after death or incapacitation because you determine how and when your assets are distributed.
- Income earned within a trust is not subject to income taxation.
- Having a trust allows you to specify your wishes regarding what happens to your estate after you pass away. For example, you can specify exactly how you want your money and trust property division among your heirs to look. Payouts can be triggered at a certain age or upon college graduation. Or, you can have them spread out over several milestones, determined by you.
Are there drawbacks to establishing a trust?
While there are many benefits associated with having a trust, there are some potential drawbacks as well. For example, setting up and managing a trust can be a complicated, costly process. Specialized expertise may be required.
- If you create an irrevocable trust (one that cannot be altered or revoked), you may lose control over how your assets are managed and distributed.
- If you choose an incompetent trustee, then they may mishandle the trust funds or fail to properly manage them according to your wishes.
- You may have difficulty assigning beneficiaries if there are disagreements among family members regarding who should receive what portion of your estate when you pass away.
- While having a trust can provide protection against creditors, it doesn't guarantee that all debts will be avoided. Certain types of debt may still be pursued by creditors, depending on state law.
Make sure you understand the differences between an irrevocable and a revocable trust before establishing one.
FAQ about trusts and divorce
Can assets held in a trust be divided during a divorce?
Maybe. Assets held in a trust are subject to division during a divorce if they are determined to be marital property. This determination must be made before any division can take place.
How is this determination made? Various factors are at play, including when the trust was created, the terms of the trust, whether a prenuptial agreement was signed (and its terms), and who had access to its assets.
If a trust was established prior to marriage and no marital assets were added to it during the marriage, it's possible that the trust would not be marital property. Therefore, it would not be subject to distribution.
What happens to a trust if one spouse dies during the divorce process?
If one spouse dies during the divorce process, the trust will pass unchanged to their beneficiaries as described in the trust.
Are there any tax implications for setting up or dissolving a trust during divorce proceedings?
Yes, there are tax implications for setting up or dissolving a trust during divorce proceedings. Any transfer of ownership or funds could result in capital gains taxes or other tax liabilities. It is important to consult with an accountant before making any decisions regarding trusts and taxes during a divorce settlement.
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