Third Party Trusts and Divorce

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A thorny and overlooked issue in divorce cases involves what the law calls “third party trusts” – essentially, assets held by a third party, often a parent or grandparent, for the benefit of one of the spouses, usually the child or grandchild.

Let’s use a simple example.  Grandfather wants to gift a certain sum to granddaughter for her sole benefit, and to accomplish this he creates a trust where the granddaughter is the sole beneficiary.  The trust could pay yearly income, disburse funds when the granddaughter reaches certain ages, or simply sit until some defined point of transfer.  When the trust is created, the granddaughter is not married.  Granddaughter subsequently gets married and is now getting a divorce.  Can the soon-to-be former husband claim an interest in this third party trust?

Many people think the answer to this question is easy.  The grandfather created the trust for the granddaughter so it is her separate property.  But the answer is not actually that easy, depending upon the trust activity and also the language creating the trust.  If, for instance, the trust makes mention the money would be used to help the granddaughter and her spouse when she married, that language could be considered an intent to share the proceeds, at least during the marriage, creating a marital interest.  Also, the trust could pay monthly or annual income to the granddaughter, who receives the money as income.  If that income is shared with the spouse or used to pay for marital assets or debts, that type of commingling would put the whole trust in jeopardy.  In general, any income received by a spouse during the marriage is marital property, so if the spouse does not take steps to separate the money and show an intent to keep it separate, the spouse may be unwittingly giving the other spouse a claim to the trust.

So, if the third party trust is actually more complicated than originally thought, what can a beneficiary spouse do to protect the asset?

First, the grantor of the trust – the grandfather in our example – could make explicit in the trust agreement that it is solely for the benefit of the granddaughter and is not intended for the use or benefit of any current or future spouse.

Second, the grantor and the beneficiary could establish a separate bank account where all of the funds disbursed will be deposited, and these funds will be in the sole name of the beneficiary and not used in any joint account with a spouse.

Third, the beneficiary could have a prenuptial agreement that says both the corpus and any income from the trust remain the sole and separate property of the beneficiary.

Generally, these three steps will adequately protect the interests of the beneficiary spouse and avoid accidentally creating an interest in the trust in the other spouse.

As you can see, third party trust assets have significant implications in divorce and should be addressed at the time of the creation of the trust or prior to the marriage.

If you have questions about third party trusts and divorce, contact us – we can help.