Protecting Gifted Property in Case Your Child Divorces

Clients often ask if there is a way they can financially provide for their children without making that money available for their child’s spouse to take in a divorce. Gifting property to the child outright without any legal protections is just asking for trouble.  The two best alternatives are a premarital agreement, and a discretionary, asset protection trust.

In Colorado, divorcing people normally keep their separate property and divide their marital property.  Separate property is the property each came into the marriage with and any property gifted to them, whether before or during the marriage, that has not been commingled with the other spouse’s property. Marital property is what is earned or accumulated during the marriage, including the appreciation in value of separate property during the marriage.  Yet courts can “equitably divide” marital property to consider the “economic circumstances of each spouse,” thus giving one spouse more of the marital property than the other.

Premarital agreements, also known as pre-nups define the rights of each spouse to the property of the other upon divorce or death and identify whether and to what extent the debts of one are the obligations of the other.  A discretionary, asset protection trust contains a spendthrift clause and provides the trustee with broad discretion in making distributions to the beneficiaries such that the beneficiary’s creditors, including the soon to be ex-spouse, generally cannot reach money in the trust.

In Colorado, only property in which a person has a legal interest can be divided in a divorce.  If a person only an “expectancy” to one day receive money, there is no current interest in property to be divided in the divorce.  Expectancies are interests that can be amended or revoked, such as what the named beneficiary of life insurance has prior to the death of the insured, because, prior to passing the owner can change the beneficiary at any time.  Expectancies also include the interest a named beneficiary has in another’s will, revocable living trust, retirement plan, and the like, while that person is alive. Once that person dies and the interest can no longer be revoked, it matures into a true interest that is capable of being attacked by creditors, including the ex-spouse in divorce.

The best protection is a pre-nup.  In addition to the standard language mentioned above, it is important that the agreement also address any trusts in which the child is a beneficiary, including any appreciation in the value of the trust.  Critically, the child needs to be instructed to respect the terms of the agreement by not commingling their property with, or co-signing on debts of, the other.

Trusts can also provide significant protection from the predator spouse.  If the trust you create is a revocable living trust (RLT), the child’s interest is merely an expectancy while you are alive and it is not subject to division.  Upon your death, the trust becomes irrevocable and the child’s interest vests and is now considered his/her separate property.  While an ex cannot directly get the separate property of the other spouse, the court can consider it when equitably dividing the marital property.  For example, assume the trust is worth $1,000,000, and the couple’s marital property is worth $2,000,000.  Though the predator is not entitled to any of the $1,000,000 trust, the court could award $1,500,000 of the marital property to the ex-spouse and $500.000 to your child as a result of its consideration of the “economic circumstances of each spouse.”

That sounds pretty dire.  It also seems like a trust is of no value in protecting your property in this situation.  However, recall that to the extent an interest is “amendable or revocable,” it is merely an expectancy.  So the more restrictions on the rights of your child to access the property in the trust, the more his/her interest will either be deemed “amendable or revocable,” or at least of lesser value.  How can that be done? The inclusion of a spendthrift clause and significant, if not complete, discretion placed in the hands of an independent trustee as to whether, when and in what amount to distribute to the child will accomplish this.  The ability of a trustee to decant to another trust is also a very effective tool. Vested rights of a child are problematic, even if they are future rights, like the right to receive one-third at age 30. The more uncertainty as a result of the discretion or decanting, the lower the value a judge may attach to your child’s interest.

Needless to say, these matters are complex and best discussed with an attorney.  With good planning, it is possible to provide a great gift to your children and protect it in the event of a divorce.

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