IMPORTANT UPDATE: Read an important update on this post here. The Supreme Court decision in Tannen v. Tannen has now come down and it seems using "ascertainable standards" is now permissible.
One common goal many parents have when planning their estates is protecting their children's inheritances from a divorcing spouse. With the divorce rate at 50%, this is a wise concern. One way in which clients are often smarter than asset protection planners is that they realize that the statistically most likely creditor to attach their family's assets is a divorcing spouse.
The most common way to protect the assets you desire to leave your children from divorcing spouses or any other creditor is through use of a spendthrift trust. A spendthrift trust is a legal relationship that can either be created during your life or after your death in your will. Like any other trust, it has a funky way of functioning.
The assets placed into trust have two owners. The "legal" owner is the trustee of the trust. The trustee manages all assets and has full control over them. However, the trustee has a duty to use the assets for the benefit of the "beneficiaries", who are the "beneficial owners" of the trust assets.
This all sounds pretty complicated, but it can be broken down pretty simply. Think of assets that are put into trust as being held in a box where for the most part no one can get to them. While the assets are in the box, the trustee has full control over their management. However, the trustee cannot remove the assets from the box for his own personal purposes. As soon as the trustee opens the lid on the box and starts taking stuff out, that stuff goes directly to the beneficiaries. While stuff is in the box, creditors (and divorcing spouses) shouldn't be able to touch it. After stuff comes out of the box, then creditors and divorcing spouses can get it. This is more or less how the common law of trusts has functioned for hundreds of years.
As you can see, this is a pretty good setup. You can leave your children their inheritances in trust and when they need money for legitimate purposes, the trustee opens up the box and gives them what they need. When a spouse files for divorce on the other hand, the box stays shut and the assets stay out of reach. This is of course an oversimplification to some degree, but it is a good description for purposes of this post.
Traditionally, most trust documents stated that the trustee should "open up the box" to make distributions for the "health, education, maintenance, and support" of a beneficiary. This was called an "ascertainable standard". Over time, this has almost become the formulaic trust language, and is in almost every trust I see.
Over the past decade, two documents have come about which have drastically altered the traditional description of trusts above: the Restatement (Third) of Trusts and the Uniform Trust Code. One of the major changes proposed by both is the creation of a property right held by the beneficiaries of a trust, even when the trustee has discretion over trust assets. The problem with this is that once a beneficiary has a property right in the trust assets, those assets are reachable by a spouse in divorce.
Luckily in New Jersey, our legislature has not adopted the Uniform Trust Code so its provisions are not a problem at the current time. Nor at the current time have our courts adopted the approach of the Restatement (Third) of Trusts. However, due to a recent case, I believe there are still precautions to take.
In Tannen v. Tannen, 416 N.J. Super. 248 (2010), the court specifically declined to adopt the Restatement (Third) approach in a divorce case. However, the court indicated that the New Jersey Supreme Court should consider reviewing the case and adopting Restatement (Third) approach. After reading this case, until the New Jersey Supreme Court finally does rule on the issue, I am operating under the assumption that the Restatement (Third) approach could become a reality here.
That leaves the obvious question: how do we prepare to mitigate the Restatement (Third)? I believe the best we can do is to revisit the "ascertainable standard" form language mentioned earlier. Under the Restatement (Third) approach, the beneficiaries clearly have a property right in trust property, at the very least to the extent they are entitled to distribution under the standard of distribution outlined in the trust. For that reason, I have for the most part dropped that "normal" ascertainable standard from my trust language and instead allowed the trustee to make distributions "in his sole and absolute discretion, for any purpose or no purpose". By making distributions discretionary to such a strong degree, I hope to make the best argument possible that the beneficiaries have little or no enforceable right to distribution, thereby limiting exposure to divorcing spouses to the maximum extent possible under the law.
The language does sound scary in that it gives the trustee so much discretion, but I believe this can be mitigated by choosing a reputable trustee. Also, despite the amount of discretion, the trustee still has a "fiduciary duty" to the beneficiaries which means he can be removed from his post by a court if he goes rogue and stops acting in their best interests. Despite the language, most case law generally holds that there is no such thing as a truly unreviewable standard of discretion for a trustee.
Trusts can be a little tricky, but they are a very powerful tool. If you are interested in learning more about using trusts to protect your children's inheritances, contact me for an appointment today.
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