For many parents, estate planning is about more than just determining who will receive their assets, it’s about making sure those assets stay within the family. One of the most common and often overlooked risks to an inheritance is divorce or third-party creditor claims.

Without proper planning in place, assets you intended to be left to your child(ren) could ultimately end up in the hands of a former spouse. This concern can be alleviated, however, with thoughtful, proactive estate planning that is crafted in a way to protect your assets, streamline the distribution of those assets to your bloodline, as well as reduce the risk that funds distributed to your child(ren) are subject to any ongoing or future divorce proceeding.

Why Divorce Can Put an Inheritance at Risk

Massachusetts follows a minority rule when it comes to property division following a divorce proceeding. Massachusetts is an equitable distribution state, meaning that in a divorce, courts divide marital property in a manner they deem fair and equitable based on a variety of factors. Equitable division does not necessarily mean equal. Judges have wide discretion during property division hearings and will divide assets based primarily on factors such as overall fairness, age and health of each spouse, length of the marriage, each party’s need for income, etc.

While inheritances are generally considered separate property (not subject to equitable division), that protection is not absolute.

In practice, inherited assets can lose their “separate” designation if they become commingled with marital property. This can happen more easily than many people realize. For example, if your child deposits inherited funds into a joint account, uses those funds to pay for shared expenses, or retitles inherited property into both spouses’ names, a court will likely consider some or all of those assets subject to division in a divorce.

Even when assets remain titled in one spouse’s name, Massachusetts courts have broad discretion and may still take those assets into account when determining an equitable division. This is especially true absent a prenuptial agreement signed before the marriage.

The Benefits of a Prenuptial Agreement

A prenuptial agreement (prenup) is a legally binding contract between individuals that intend to marry, that outlines important provisions that will govern in the event of divorce. Prenuptials allow both parties to contract around provisions such as asset division, debts, spousal support (alimony), and other important consequences of divorce that would otherwise be left to a Judge to determine.

A standard prenuptial agreement requires asset disclosure, where both spouse’s make clear distinctions as to what shall be deemed “separate” property of each respective spouse. This allows each spouse to retain full legal ownership in the property that they own individually prior to entering the marriage. In doing so, each spouse typically waives their rights to the other’s separate property. Unless these assets later become commingled as mentioned above, they would not be subject to equitable division upon divorce, and the prenuptial would govern how assets would be distributed rather than a Judge.

When it comes to inheritance, a prenuptial is also the best approach to protect each spouse’s interests if they are expecting any future inheritance. Similar to the financial disclosure that each spouse completes, most prenuptial agreements also require each spouse to relinquish any and all rights to any future inheritance of the other spouse.

That said, it is not uncommon for people to be reluctant to enter into a prenuptial. It may be especially difficult to encourage your child to enter into a prenuptial before they get married. In such event, you have additional methods that you can explore in the creation of your own estate plan to protect your child’s inheritance from any future divorce.

The Limitations of Leaving Assets Outright

A common approach in estate planning is to leave assets directly to children through a Will, a Trust, or beneficiary designation. Utilizing a Trust or designating Pay-on-Death beneficiaries directly on your financial accounts can be especially beneficial, as these methods ensure the assets do not pass through the probate court.

By operation of law, any beneficiary named directly on a financial account (such as a checking, savings, brokerage, retirement account, or life insurance policy) will receive those funds automatically, with no need for probate court approval. The beneficiary simply fills out and returns the required beneficiary claim form, along with a certified death certificate, and legally obtains title to those assets. For a full legal blog post outlining the importance of keeping your beneficiary designations up to date, please read our full legal blog here breaking down a Massachusetts Superior Court decision.

While this option is straightforward and efficient, this method offers little to no protection once the asset is received upon your death.

When assets are distributed outright, they become the legal property of your child. From that point forward, those assets are exposed to the full range of life events, including divorce, creditor claims, etc. There are no built-in safeguards to prevent commingling, and no structure in place to preserve the inheritance as separate property over time. As for other creditor claims, once assets are titled in your child’s individual name, your child’s creditors have a clear path to collection. This will in turn reduce any potential inheritance they receive, as either a portion or the entirety of the inheritance, could then be used to satisfy their own individual debts.

For families who want to ensure that inherited assets remain protected, a more deliberate and proactive strategy is often necessary.

Utilizing Trusts to Protect an Inheritance

One of the most effective ways to protect a child’s inheritance from divorce is through the use of a properly structured trust. Whether through a Revocable or Irrevocable Trust, which offer several different advantages and disadvantages based on your needs, clients often approach us with the intent to leave everything in their trust to their children at a set age. This is often an arbitrary number selected by the client, set at age 21, 25, or 30. For more information about why setting this age at 25 or above provides several important protections, as well as the benefits of a pot trust structure for clients with minor children, read our full legal blog here. For clients with adult children well into their 40’s, 50’s, or beyond, this is typically less of a concern.

Rather than utilizing a rigid trust structure that requires the Trustee to make an outright distribution at a set age or milestone, you can protect your child’s inheritance by instead granting the Trustee the discretion to continue to hold those funds in trust for your child’s benefit. Incorporating flexibility into your Trust will ensure that the acting Trustee can make discretionary distributions (typically for your child or beneficiary’s health, education, maintenance, and support) at any time, but similarly can withhold distributions if it is not in the child or beneficiary’s best interest to receive a lump-sum distribution, outright and free of trust.

This strategy is vital as it ensures that the legal title to all of the Trust assets is held by the Trustee of the Trust. As soon as the Trustee makes an outright distribution to any beneficiary, those assets are now legally titled in the individual name of the beneficiary. So long as the Trust, rather than the individual child, is the legal title holder to those assets, they will be shielded from creditors and will reduce exposure to those assets being included in any possible division in the event of a divorce.

In some circumstances, parents may choose to keep assets in trust even longer, or indefinitely, rather than making outright distributions. There may be other concerns outside of divorce that warrant a similar type of strategy, such as a beneficiary struggling from financial immaturity, a gambling addiction, substance abuse, etc. This is another reason why incorporating a Revocable Trust into your estate plan grants you the utmost flexibility. As life changes, you can always amend and update your trust to reflect your new intent and work with an attorney to incorporate whatever strategy makes the most sense for your unique situation. For our legal blog outlining what you need to know about creating a Will and Trust in Massachusetts, read our full legal blog here.

Additional Protections with a Spendthrift Provision

All of our Revocable Trusts include what is known as a spendthrift provision, which prevents a beneficiary from voluntarily or involuntarily assigning or pledging their interest in the trust. Not only does this prevent your beneficiaries from assigning their trust interest, but it also prevents your beneficiary’s creditors from attacking the trust in an attempt to compel a distribution. This adds an added layer of protection for both you and your children.

Whether your child is going through a divorce, has significant debts, is subject to an outstanding judgment lien, etc., this clause ensures that your beneficiary’s trust interest cannot be utilized to satisfy any such debt or lien. Similarly, it ensures that your child/beneficiary named in the trust cannot sell or assign their future interest in the trust property to someone else.

This clause aids in reinforcing your intent and ensures that the maximum value possible makes it to your trust beneficiaries, rather than being left in the hands of a beneficiary’s creditors, ex-spouse, etc.

Why Discretionary Power Matters

In many cases, incorporating discretion into the trust is key to maximizing protection. When a Trustee has discretion over distributions, the beneficiary does not have an absolute right to demand assets. In the same manner that a third-party creditor could not compel a distribution, neither can the beneficiary. This distinction can be significant. It is recommended to build in an “ascertainable” standard for the Trustee. This restricts the Trustee’s discretion to make distributions only for specific, authorized purposes. Typical discretionary language authorizes the Trustee to make distributions for the beneficiary’s health, education, maintenance, and support (oftentimes referred to as HEMS for short). This has important implications when it comes to both creditor protection and estate tax implications (if the acting Trustee is also a beneficiary).

This standard is especially important if you have one of the trust beneficiaries named as the Trustee. If the Trustee is also a beneficiary, without an ascertainable, objective standard in place, a strong argument can be made that the beneficiary has sole control of those assets and the trust can be attacked. This standard is also vital when it comes to estate taxes, as it allows beneficiaries who are also serving as Trustee to avoid adverse tax consequences by removing the trust assets from their own gross taxable estate. Lastly, this standard protects the Trustee, and grants them the power to reject a beneficiary that is demanding a distribution for anything under the sun. Unless the request falls within the HEMS standard, or any other category that authorizes the Trustee to make a distribution, the Trustee has no power or authority to comply. Moreover, many trusts will direct the Trustee to make any authorized distributions or payments to any third-party directly, to guarantee that the trust funds are being utilized for the correct and intended purpose. 

The Role of the Trustee

The effectiveness of any trust depends in large part on the person or institution serving as trustee. This individual is responsible for managing the assets, making distributions, and carrying out the terms of the trust. The Trustee serves in a fiduciary role and is required to meet a very high ethical standard. As a fiduciary, they must carry out the terms of the trust in satisfaction of their duty of care, loyalty, and good faith.

Choosing the right trustee is essential. A trustee should be someone who is responsible, impartial, and capable of exercising sound judgment. In some cases, families choose a trusted individual. For others that may not have a trusted family member or that don’t want to cause unnecessary family rifts, a professional trustee may be more appropriate to ensure consistency and objectivity.

For a full overview of considerations when selecting your Trustee, and whether a professional Trustee is right for you, read our full legal blog here.

A Thoughtful Approach to Protecting Your Legacy

Divorce is just one of many life events that can impact an inheritance, but it is one that can have lasting financial consequences. With proper planning, it is possible to significantly reduce that risk while still providing meaningful support to your children.

By incorporating strategic trust planning into your estate plan with discretionary powers granted to the Trustee, you can ensure that the assets you leave behind are preserved for the people you intended, and you practively account for situations that are beyond your control.

Estate planning strategies should always be tailored to your specific goals and family dynamics. If you are concerned about protecting your children’s inheritance from divorce or other potential creditors, contact an experienced Massachusetts estate planning attorney at Lane, Lane & Kelly, LLP to put the right structure in place that provides you with the utmost peace of mind, and protects your intent even after you are gone.

 This blog is made available for educational purposes only as well as to give you general information and a general understanding of the law, not to provide specific legal advice. By reading this blog you understand that there is no attorney client relationship between you and Lane, Lane & Kelly, LLP.