Inheritance Protection for Married Children
| Jurisdiction | Colorado,United States |
| Citation | Vol. 41 No. 11 Pg. 97 |
| Pages | 97 |
| Publication year | 2012 |
2012, November, Pg. 97. Inheritance Protection for Married Children
November 2012
Vol. 41, No. 11 [Page97]
Trust and Estate Law articles are sponsored by the CBA Trust and Estate Section. Topics include trust and estate planning and administration, probate litigation, guardianships and conservatorships, and tax planning.
Coordinating Editors
David W. Kirch, of David W. Kirch, P.C., Aurora-(303) 671-7726, dkirch@dwkpc.net; Constance D. Smith, of Fairfield and Woods P.C.-(303) 894-4474, csmith@fwlaw.com
About the Authors
Edward D. Brown is a principal in the Denver-based law firm of Engel and Reiman pc, founded in 1984. He has extensive experience in the areas of integrated estate planning and taxation-e.brown@engelreiman.com. Hudson Mead is a Senior Trust Officer with J.P. Morgan Private Bank who manages the trust administration in the Rocky Mountain Region-hudson.mead@jpmorgan.com. The authors thank Marc Chorney for his thorough book on trusts and divorce property divisions, Trusts in Divorce Property Divisions (CBA-CLE, 2011), and Steven B. Epstein of Litvak Litvak Mehrtens and Epstein, P.C. for his contributions to this article.
This article discusses the state of trust law in divorce situations generally, the views that Colorado has taken in this regard, and what the planner can do to protect the family inheritance.
Estate planners often focus on taxes and family wishes as the primary principles of a solid estate-planning strategy. This seems like a logical formula for estate planning success, but there is an equally compelling reason to focus on an often-overlooked principle. Many clients are so busy planning for taxes and creating distribution schemes that they fail to consider the very real possibility of their child's divorce.
The biggest creditor of a lifetime often is a spouse. With a 50% divorce rate that is projected to continue or increase through future generations, the planner and client must anticipate that a divorcing spouse may try to intercept a child's inheritance. It therefore is imperative that estate planners and clients address inheritance protection for future generations.(fn1)
To help estate planners explore inheritance protection for children, this article provides an overview of trust law in divorce situations and relevant Colorado law. It then focuses on practical steps planners can take to assist clients who wish to protect the family inheritance for future generations.
A Hypothetical Scenario
A fairly typical discussion and plan regarding children and the protection of inheritance may begin as follows. When it comes to the marriage of their children, many clients insist their estate planner draft the first line of defense-the marital agreement.(fn2) The planner either places a marital agreement requirement in the estate plan, barring inheritance without one,(fn3) or-more typically-broaches the subject of whether a pre- or post-nuptial agreement is in order. Some children will refuse to enter into such agreements, fearing their future spouse will think they have "one foot out the door." If the child does follow through, engaging in such agreements may create tension among the parties, will require separate legal counsel for each spouse, and at times may result in a negotiated compromise that satisfies no one. Each party may enter into defensive posturing and reveal true feelings as to what he or she feels entitled. Thus, although a marital agreement is a good protection device, it is not always practical.
After the marital agreement is explored, many planners have completed their asset protection review and move on to discussing the dispositive provisions of a trust. In the past, trusts simply have distributed assets outright to children at the parents' deaths and were used as a probate-avoidance device. Later, planners and clients began to craft the trusts to prolong distributions based on age. Thus, assets would be distributed when a child reaches a certain age. For example, one-third of the assets might be distributed at age 30, half of the remaining trust corpus at age 35, and the remainder at age 40.
At the same time, the trustee often is directed to distribute assets for health, education, maintenance, and support-the "HEMS standard." The trust also may feature a "5 and 5" power, permitting the beneficiary to withdraw the greater of $5,000 or 5% of the trust corpus in any given calendar year. A spendthrift clause can be included and relied on to prevent the alienation of trust assets to third parties.
This typical trust document is prevalent today, if not fairly standard. It also has been under attack in family courts around the country. The current battle focuses on whether a trust beneficiary has a property right or only a mere expectancy. The question is whether a person has a right to trust property or whether the chances of receiving that property are too remote to amount to a right. If the former, the property must be identified as being marital or separate property. To the extent it is found to be separate property, the court can consider it an "economic circumstance," which allows the court to direct more marital property to one spouse over the other. To the extent it is found to be marital property, it is subject to division by the court.
State courts addressing similar trust attributes offer inconsistent outcomes as for whether the trust property constitutes property, and as to what type, for divorce law purposes. A review of trust attributes and outcomes follows.
Age Attainment and Remainder Interests
Beneficiaries can be granted current rights to trust income and principal. For example, all of a trust's current income can be mandated to be distributed quarterly to the beneficiary. In contrast, a beneficiary could be prohibited from receiving any financial benefit from the trust until the beneficiary attains a certain age or survives another individual (referred to as a remainder interest). A recurring issue that presents itself in a divorce is whether a remainder interest constitutes property subject to division in divorce. Many states recognize the "gifted" nature of such a trust interest as being separate property and therefore not marital property subject to division. However, many states, including Colorado, treat the income and appreciation relating to that separate property, which accrued during the marriage, as marital property subject to division. In these states, the beneficiary generally desires that such separate property, including its income and appreciation, not be treated as property at all for purposes of the division of assets in a divorce.
Case Law
Courts differ on how they view remainder interests. The Supreme Court of Pennsylvania ruled that receiving trust assets on attaining a certain age was a "mere expectancy." However, voluntarily leaving those assets in the trust after attaining the age leaves the appreciation of those assets vulnerable to division as marital property.(fn4) Property to be held for a fixed period of years and then distributed equally to beneficiaries also can amount to an expectancy and thus not be divisible in divorce proceedings.(fn5) In Indiana, trust assets were found not to be includable for property division where the spouse would receive trust property outright only on the death of the income beneficiary. The court concluded the future interest was too remote and thus was an expectancy.(fn6)
On the other hand, a remainder interest subject only to surviving the income beneficiary was divisible in Trowbridge v. Trowbridge, because it was ruled part of the remainder beneficiary's estate for the property division statute in Wisconsin.(fn7) In Davidson v. Davidson, a remainder interest subject only to surviving the income beneficiary also was found to bevulnerable to division where it was "fixed" at the time of divorce, even when the trust document contained a spendthrift provision.(fn8)
A remainder interest contingent on the death of the income beneficiary was property subject to division because it amounted to a "vested interest in the trust."(fn9) The remainder interest contingent on the death of the income beneficiary was includable in the marital estate because it was a "vested future interest subject to...
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