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Good estate planning includes taking steps to protect a family’s wealth from various risks. A common risk is the possibility that a child or other family member might become entangled in a divorce. Our experiences and our observations of those around us demonstrate that the possibility of divorce is very real. And with it comes the potential for assets that we intend to transfer to family members to be at risk.
Clients should weigh the possibility of divorce when planning their estates. Those who are concerned about this possibility should create trusts for family members instead of transferring assets to them outright. With a properly-designed trust, it is possible to avoid the direct transfer of the family’s assets to a beneficiary’s ex-spouse as part of the division of their “marital estate.” Instead, the role of the trust in the divorce proceeding can be limited to being a factor that might indirectly affect the division of other assets that are included in the marital estate.
Trust design features to consider
Two cases decided recently by the highest court in Massachusetts, Pfannenstiehl v. Pfannenstiehl (2016) and Ferri v. Powell-Ferri (2017), indicate that clients may reduce the risk of a court including a trust interest in a beneficiary’s marital estate if their trusts include one or more of the following design features:
- Multiple current beneficiaries – A beneficiary’s trust interest is less likely to be included in his or her marital estate if there are other beneficiaries who may currently receive distributions of income and/or principal.
- An “open” class of beneficiaries – A class of beneficiaries is “open” when it may be expanded by the birth of additional family members after the trust is established. An example would be a trust for the benefit of one’s adult child, that child’s son and daughter, and any children, grandchildren, etc. who might be born in that child’s branch of the family tree in the future.
- Broad trustee discretion to make distributions – If the trust gives the trustee broad discretion to make distributions, a beneficiary’s interest is generally viewed as being too uncertain to be a property interest that could be included in the marital estate. A narrower right to receive distributions for a beneficiary’s health, education, maintenance, or support, is more likely to be viewed as a property interest.
- No withdrawal rights at “benchmark” ages – Many trusts give a beneficiary the right to withdraw portions and then all of the trust when he or she attains certain ages. People who include these rights in their trusts have relatively little interest in controlling their wealth throughout the beneficiary’s lifetime. They also presume that at certain ages the beneficiary will be sufficiently responsible to handle the assets. Clients who are concerned about the risk of divorce should consider not including such withdrawal rights in their trusts.
- No powers of appointment – Many clients enhance the long-term flexibility of their estate plans by giving beneficiaries the power to appoint trust assets. These powers usually are exercisable at death by the inclusion of language in the beneficiary’s will. In at least one case, a Massachusetts court cited a power of appointment as a contributing factor in including a trust interest in a divorcing beneficiary’s marital estate.
The Ferri case is particularly notable for its impact on trusts that are already in existence. In that case the court strongly suggests that such a trust may not be modified by the process of “decanting” to protect the assets from a beneficiary’s divorcing spouse.
These are our general observations based on Massachusetts law. They should not be interpreted as advice for any specific client situation. Such advice would require the involvement of an experienced lawyer, with whom we would be happy to collaborate. For those clients who live outside Massachusetts, this article is informative, but consultation with local lawyer familiar with the laws of their state would be important.
Article Published January 12, 2018
Disclosure: The opinions expressed in this article are as of the date issued and subject to change at any time. Nothing contained herein is intended to constitute investment, legal, tax or accounting advice and clients should discuss any proposed arrangement or transaction with their legal or tax advisors.