Massachusetts divorce lawyer Nicole K. Levy reviews the treatment of irrevocable trusts inMassachusetts divorce cases.
In my recent blog on the treatment of future inheritances in Massachusetts divorce cases, I discussed how a divorcing spouse’s expectancy interest in a future inheritance is generally notconsidered a divisible asset for divorce purposes in Massachusetts. Today, I will look at a far more complex question of whether a divorcing spouse’s beneficial interest in an irrevocable trust may be divided as an asset in a divorce.
The starting point for this discussion is an acknowledgment that an interest in an irrevocable trust differs greatly from an interest in a future inheritance. It is plain, black letter law that a future inheritance is not a divisible asset in Massachusetts, while an already-received inheritance can usually be divided in a Massachusetts divorce. The divisibility of a beneficial interest in trust, however, is a far murkier subject. Depending on timing, the terms of the trust, the trust property, and the nature of the beneficial interest, a spouse’s interest in a trust may or may not constitute a divisible asset in a Massachusetts divorce.
The main difference between a future inheritance and an interest in trust is relatively straight-forward: a spouse’s expectancy interest in a future inheritance does not “vest” until the death of the testator (i.e. person making the will). This means that a person’s interest in a future inheritance is subject to “defeasance” – which is just a fancy way of saying that the person’s rights under the will could be defeated if the person making the will changes his or her mind and changes the will before death. In contrast, not all trust benefits vest upon the death of the trust maker (the “testator”). A person can use a testamentary trust as a substitute for his or her last will and trust, but this is only one kind of trust. Other types of trusts include:
- Real estate trust (used to own real estate; offers privacy and flexibility vs. individual ownership; also known as “living trust”)
- Nominee trust (a trust in which trustee is only authorized to act when instructed by beneficiaries)
- Asset protection trusts (designed to protect assets from creditors)
- Charitable trusts (administers funds for charities and/or philanthropy)
- Special needs trusts (used for administering funds for disabled persons)
- Tax-bypass trusts (typically used by wealthy families to minimize estate tax exposure)
- Totten trusts (similar to joint bank account; like a revocable gift that becomes payable upon testator’s death)
- Life insurance trusts (places life insurance proceeds under control of trustee, who administers on behalf of beneficiaries)
- Medicaid trusts (designed to protect assets for persons whose nursing home benefits will be paid by Medicaid)
- Investment trust (a trust designed to buy, sell and administer investments, such as real estate investment trusts)
- Spendthrift/Discretionary trusts (vests control of trust assets in trustee, who has discretion when/how to pay benefits; protects trust assets from creditors and limits beneficiaries’ control over assets)
For several of these trusts, such as tax-bypass trusts and life insurance trusts, beneficiaries may only receive benefits upon the trust maker’s death. Other forms, such as Totten trusts and real estate trusts, may deliver benefits during the trust maker’s lifetime, but may also be subject to revocation if the trust-maker chooses to terminate the trust. Still other trusts, such spendthrift/discretionary trusts, may limit beneficiaries’ right even after the trust-maker dies, by vesting sole control and authority over trust property to a trustee. The divisibility of trust benefits in a divorce vary widely, depending on a long list of factors.
Table of Contents for this Blog:
- A Comparison: Trusts vs. Last Will and Testament
- Irrevocable Trusts are Similar to Legal Gifts
- Are Revocable Trusts Subject to Division in a Massachusetts Divorce?
- Irrevocable Trusts: a Different Animal
- Revocable Trusts: Unlikely to Prevent Assets from Being Divided in a Divorce
- Irrevocable Trusts in Massachusetts Divorce Cases
- A Major Appellate Decision in Massachusetts: Pfannenstiehl v. Pfannenstiehl (2016)
A Comparison: Trusts vs. Last Will and Testament
A person’s last will and testament is an inherently revocable instrument, up until a testator’s death or incapacitation. “Revocable”, in this context, means that the maker of the will (the testator) can generally change his or her mind regarding who will receive what shares of the testator’s estate, up until his or her death. We have all heard of disgraced relatives being “written out the will” of a well-heeled parent or grandparent. Well, the possibility that a spouse might be “written out” of a will means the spouse’s “right” to receive a future inheritance from a still-living relative is considered a “mere expectancy interest” should that spouse get divorced. The moment the relative actually dies, and the spouse’s inheritance vests, it becomes possible to divide the spouse’s inheritance in a divorce. Prior to the relative’s death, the “mere expectancy interest” in a future inheritance typically cannot be divided. The word “expectancy” reflects the uncertain nature of the interest; the individual expects to receive under the will, but his or her expectation is subject to the testator living out the remainder of the testator’s life without changing the will. The fact that a testator can change his or her will prior to death is what makes a will revocable – because terms of the will can be revoked or modified.
The starting point for understanding trusts is knowing that a trust – unlike a person’s last will and testament – can begin paying benefits to a beneficiary immediately, instead of waiting until the trust maker’s death. Thus, a wealthy person can create a trust – while they are alive – that begins pays benefits to his or children (or anyone else) while the trust-maker is still alive. If the wealthy person creates a revocable trust – i.e. one that can be modified or terminated at the trust maker’s command – then the beneficial interest looks more like a mere expectancy interest. Just as a person can be “written out of a will” before the testator’s death, the beneficiary of a revocable trust could see his or her benefits cut off at any time the trust-maker sees fit.
One way to understand this dynamic is this: while a last will and testament only transfers property upon a testator’s death, a trust can transfer money and property while the testator still lives. Instead of being limited to an inheritance-payable-upon-death, a trust is a way for living people to make gifts and transfer property during their lifetimes. (Again, some trusts – known as testamentary trusts – behave almost exactly like a last will and testament, and would be treated similarly in a divorce. However, there are many more types of trusts than this.)
Last, we must address the question of revocable vs. irrevocable trusts. Put simply, a revocable trust is a trust in which the testator reserves the right to revoke, modify or change the trust if he or she so chooses. An irrevocable trust is one in which the testator does not have the right revoke, modify or change the trust after it is formed. Whatever property the testator places in an irrevocable trust belongs to the trust forever. (Of course, if the testator names him or herself a beneficiary under the irrevocable trust, some of that property may return to him or her later.)
Laypersons might wonder: why would anyone ever make irrevocable trust? Why not always reserve the right to change the trust that you created? The answer boils down to this: a person who creates a revocable trust is generally considered the true owner of the trust property, in some form or fashion, because they reserved the right of revocation. Thus, creditors, tax-collectors and divorcing spouse’s can reach the property. However, an irrevocable trust separates legal ownership of the trust property entirely from the trust maker, while guaranteeing the trust-maker a degree of control over how the property is used. For example, a dog lover might place $5 million in a trust that she creates for purpose of helping stray dogs throughout America. The $5 million now belongs to the trust, period. But the trust maker has not simply given the money away. Rather, the trustee must use the $5 million exactly as the trust requires, even if it means creating lavish dog hotels with amusing names. If the trust requires the construction of doggie hotels, then the trust must build doggie hotels. In short, the trust-maker no longer owns the $5 million, but he or she still controls the $5 million, to the extent that the trust specifies exactly how the $5 million must be spent.
Irrevocable Trusts are Similar to Legal Gifts
One way to understand irrevocable trusts is through the simpler concept of a gift. To qualify as a gift, one person must make a definite, voluntary transfer of property to another person, and the transfer cannot be made in exchange for money or other consideration. What is important is this: if a transfer qualifies as a gift, then the gift can never be “taken back” – no matter how overly generous the gift-maker or undeserving the gift-receiver later appears. The moment the gift is completed, the property is owned completely by the recipient.
A person who creates and transfers property to an irrevocable trust is essentially making a gift. Once the trust is created, and the transfer made, the property belongs to the trust. Period. The trust cannot be revoked and the gift cannot be taken back.
Are Revocable Trusts Subject to Division in a Massachusetts Divorce?
Before moving to the complex issue of dividing irrevocable trusts, we should deal with a simpler question: is a person’s interest in a revocable trust even an asset that can be divided in a divorce? Invariably, the answer to this question depends on who created the trust. Unlike a will, which serves a single purpose of transferring assets upon death, trusts are frequently used by living people to hold property. For example, any person who owns real estate in trusts that the landowner created for his or her own benefit.
Generally speaking, a trust maker (testator) cannot prevent his or her assets from being divided in a divorce by placing the assets in a revocable trust. Because trust can be revoked, most courts will continue to view the trust maker as the true owner of any assets held by the trust at the time of the divorce.
In the divorce context, the beneficiary of a revocable trust will usually be viewed as holding an expectancy interest, like a future inheritance, which means the spouse-beneficiary’s interest is generally not subject to division. Because the trust is revocable, the beneficiary’s interest in the trust is subject to defeasance (see my prior blog for more on defeasance). Thus, an interest in a revocable trust generally cannot be divided in a divorce.
(It is important to note, however, that even revocable trusts can be quite complex, and general statements and legal principles are subject to numerous exceptions. For example, a revocable trust could be funded with property belonging to multiple individuals, including some beneficiaries and non-beneficiaries. Who has the power to revoke the trust? How would the assets be divided if the trust was revoked? In the divorce context, such details matter a lot.)
Irrevocable Trusts: a Different Animal
Irrevocable trusts are unique under the law. Although the trust maker (testator) may irrevocably transfer his or her assets to the trust, this does not mean the assets are beyond his or her control. On the contrary, the trust maker controls exactly how the trust will use its assets. The trust maker can (and often does) name him or herself trustee over the trust. From this position, he or she controls how assets, income and property based on the rules set forth in the trust instrument. The flexibility and variety of trusts that can be created is enormous.
In the divorce context, the treatment of irrevocable trusts depends on numerous questions including:
- Who created the trust?
- How many beneficiaries are there under the trust?
- Are there future “unborn” beneficiaries under the trust?
- Who is the trustee in charge of administering the trust?
- Most importantly: what rights do beneficiaries have under the trust?
Irrevocable Trusts Created by a Spouse for the Benefit of Him or Herself
If a trust maker (testator) creates a trust for his or her own benefit, to hold his or her own assets, then the beneficial interest is generally a divisible asset in a divorce. In other words, you generally cannot avoid the division of assets by placing your own assets in an irrevocable trust for your own benefit.
Trusts Created by a Spouse for the Benefit of a Non-Spouse
The equation can change if the trust maker creates a trust for the benefit of a non-spouse. For example, imagine that a husband creates an irrevocable trust for the benefit of his brother, then transfers a vacation home the husband owns to the trust for the sole benefit of his brother. Husband tells his wife that he is placing the property in trust, but does not explain the details. Three years later, the wife files for divorce. Will the vacation home be treated as a marital asset in their divorce?
If the husband transferred full legal title for the real estate for the sole benefit of his brother, then the property will likely be excluded from the division of assets. Why? The husband no longer owns the property. (Indeed, this scenario is no different than if the husband had sold (or gifted) the property directly to the brother for $10.)
There are two risks faced by the husband in this example, however. First, a court could invalidate the deed if there is evidence that the husband did not truly intended to transfer permanent ownership of the property to the trust/brother. For example, maybe the brother testifies at trial that the husband said the trust would only hold the property until the divorce ended, then the husband would get it back. Such a transfer, made for the sole purpose of avoiding the division of assets, could be deemed fraudulent and revoked by the court. A more likely risk faced by the husband in this hypothetical is that the court finds the husband’s transfer of the property was a wasteof marital assets. Consequently, the court may order that the wife receive a larger share of the remaining assets, while the husband receives a smaller share. (It is important to note, however, that there also scenarios when the husband’s transfer to the trust has no negative impact on the husband’s position in a subsequent divorce.)
Trusts Created for the Benefit a Spouse by a Third Party
This is what you, dear reader, have been waiting for. The proverbial “trust fund” created is usually created by a wealthy grandparent with the intention of providing financial support to grandchildren and later generations. What kind of trust fund are we talking about? Grant Keebler, an attorney specializing in family wealth transfer through generation skipping trusts, was recently asked: how much does the average “trust fund baby” have in their trust fund?
Keebler answered this way:
’ll limit the definition of “trust fund babies” to children whose grandparents were wealthy enough to pay the estate tax because those are the people I help and therefore the perspective I can provide.
The majority of clients I see with or forming trusts are worth about $20-30M, have 2-3 children and about twice as many grandchildren. The think tank figures support that amount of wealth as average for people who will face the estate tax. However, I suspect the median is significantly lower.
Almost all set aside $10M specifically for the grandchildren, the grandchildren’s children, etc… i.e. skipping over the middle generation. Its an estate tax minimization thing.
$10M growing at 3% (6% return minus a 3% inflation adjustment so we can understand the numbers) over 15 years (time from trust funding until adulthood) comes to about $15M . $15M divided by an average of 5 grandchildren is $3M each.
I think $3M is a fair guess.
So what is life like for a “trust fund baby”? Paris Hilton describes it this way:
I could easily have been just another trust-fund kid and not worked and just accepted the money from my family. … But at a young age, I decided I wanted to make my own name and be independent and not have to ask for anything. … A lot of my friends are trust-fund kids and they’ve never had a job for a single day in their lives. Their parents give them whatever they want but they have to always ask for things.
(I should note that I don’t mean to use the term “trust fund baby” as a pejorative term for trust fund recipients. This blog is written for a general audience and the term “trust fund baby” is a widely used and understood term, even among specialists like Keebler.)
As Hilton points out, trust funds are not only created by grandparents for minimization purposes. The reality is that great wealth represents great power, and many wealthy parents fear that giving their children direct and unfettered access to large sums of cash could result in irresponsible or even dangerous behavior. For such parents, an irrevocable trust is not just about tax minimization; it’s about controlling and monitoring how future generations access the family wealth. For wealthy families, a qualified trustee not only protects the family’s assets; the trustee monitors how family funds are spent, and takes steps to avoid transferring wealth to children or grandchildren who abuse the privilege.
A “trust fund baby” (as defined above) typically does not own or control the money held in the family trustee, except to the extent that he or she saves or invests the trust distributions that he or she receives. In most instances, the trustee alone determines if, when, and how much money a beneficiary receives. If a beneficiary is an upstanding citizen who uses his or her trust benefits wisely, presumably he or she will receive generous financial support from the trust. As a result of the trust’s support, the beneficiary and his or her spouse and children may enjoy wealth and financial security that far exceeds most people.
But what happens when a “trust fund baby” gets divorced? Should courts place a value on the beneficiary spouse’s interest in the trust and divide it? Should courts treat the trust as a source of income for the beneficiary spouse, and assign a share to a spouse as child support or alimony? We will explore these questions more completely below.
Revocable Trusts: Unlikely to Prevent Assets from Being Divided in a Divorce
Generally speaking, a trust maker (testator) cannot prevent his or her assets from being divided in a divorce by placing the assets in a revocable trust. Because the transfer to trust can be revoked, most courts will continue to view the trust maker as the true owner of the assets held by the trust at the time of the divorce.
A beneficiary of a revocable trust is different. These people are similar to individuals with an expectancy interest in a future inheritance, which means their interest is generally subject to division. Because the trust is revocable, the beneficiary’s interest in the trust is subject to defeasance. Therefore, an interest in a revocable trust generally cannot be divided in a divorce.
It is important to note here, however, that even revocable trusts can be quite complex. For example, a revocable trust could be funded with property belonging to multiple individuals, including some of the beneficiaries. Thus, parties and attorneys should keep in mind that someone is the true owner of the assets held in an irrevocable trust, and it is important to determine how and when the trust was both created and funded before assuming the trust property falls outside the division of marital assets.
Irrevocable Trusts in Massachusetts Divorce Cases
Issues surrounding irrevocable trusts generally arise in one of two ways in divorce cases. Scenario 1 involves a person claiming that the assets he or she transfer to an irrevocable trust are not assets subject to division in the divorce, because the property was irrevocably transferred to the trust and no longer belongs to the individual. These cases invariably turn on whether there is any evidence that the individual transferred assets to the trust to intentionally avoid the division of assets in an upcoming divorce. However, this blog focuses on Scenario 2, in which a beneficiary of an irrevocable trust argues that his or her beneficial interest in an irrevocable trust is not an asset subject to division in the divorce for the reasons explored below.
Let me paint a picture for you:
Husband (age 55) and Wife (age 46) have been married for 15 years. Husband comes from a wealthy family which relies on trusts to make payments to children. He is, in every sense of the word, a “trust fund baby”. During the marriage, husband frequently received payments from family trusts, which the parties used to fund their lifestyle. The main family trust that the husband has received payments from is an irrevocable trust created by husband’s parents for the benefit of husband, husband’s three siblings, and the heirs (i.e. children, grandchildren, etc.) of the siblings. The trust states that when a sibling dies, any benefits will pass to the sibling’s heirs. If a sibling dies without any heirs, that siblings interest is redistributed to the remaining beneficiaries. Lastly, the trust provides the trustee of the trust complete and total discretion over the amount and frequency of all payments to beneficiaries, without limitation. The trust explicitly provides that the trustee may decline to make any payments to any beneficiary, at any time, at the trustee’s sole election.
After creating the trust, Husband’s mother appointed herself trustee of the trust, meaning that she decides which children (and their children, etc.) are paid and when. Since the divorce was filed, the trustee has told Husband that he will receive no additional payments from the trust. The total assets held in the trust are $10 million. Several of Husband’s siblings have children. The trust provides that if any trust assets remain undistributed in the year 2075 – when Husband would be 109 years old – then those remaining assets will be paid out in equal shares to the siblings and their heirs, subject to various rules and conditions.
What can we say about this trust? Well, we can say that this $10 million trust was created for the benefit of husband and his three siblings (i.e. four siblings, each with a 25% interest), and their legal heirs. If a sibling dies, his interest in the trust passes to the sibling’s children. If a sibling dies with two children, then the sibling’s 25% interest will be split between the two children, who would each have 12.5% interests moving forward. If many grandchildren and great grandchildren are born, the number of beneficiaries would keep growing, as the share held by each generation becomes smaller and more diluted. In the year 2075, the trust will pay out any assets it still holds to all of the grandchildren and great grandchildren, who have received an interest from their parents. Once these final payments are made, the trust will cease to exist.
In the meantime, we know that Husband’s mother, the trustee, has absolute control over payments to beneficiaries. If the trustee decides that Husband’s sister, Sally, has excelled in life, then the trustee can reward Sally as she sees fit. If the trustee decides that Husband’s brother, Frank, is a worthless lay-about, the trust can authorize the trustee to make no payments to Frank at all. While all of this might seem a little unfair, it’s important to remember that the Husband’s mother funded the trust with her own money, and while she can never get the money back, the trust has vested the trustee with absolute and total authority to make only those payments she sees fit until the year 2075 – at which time the mother will be long dead, and some other trustee will finally pay out the trust assets to her great-great-grandchildren.
Irrevocable trusts are frequently employed by very wealthy families.
At the divorce, Wife argues that Husband is the 25% beneficiary of a trust that owns $10 million in assets. She believes that she should be entitled to a $2.5 million offset from the division of assets in the divorce, since Husband will retain his $2.5 million “share” of the trust following the divorce. Alternately, Wife asked the judge to enter an order requiring Husband to pay to Wife 50% of all future payments that Husband receives from the trust, if and when trust payments are received by Husband.
Will Wife prevail in her argument? Probably not. We explore the reasons why below in our review of Pfannenstiehl v. Pfannenstiehl (2016)
A Major Appellate Decision in Massachusetts: Pfannenstiehl v. Pfannenstiehl (2016)
In Pfannenstiehl v. Pfannenstiehl, the Supreme Judicial Court considered similar facts to those set forth above, and ultimately decided that a husband’s beneficial interest in an irrevocable discretionary family trust was not an asset subject to division in a Massachusetts divorce. The Pfannenstiehl decision was unique, inasmuch as it represents a rare example of the Massachusetts Supreme Judicial Court (SJC) overruling a decision of the Massachusetts Appeals Court. In 2015, the Appeals Court had held that the trust in question was a marital asset subject to division. The next year, the SJC held just the opposite.
In Pfannenstiehl, the Husband and Wife were married for twelve years and had two children. They were divorced in the Norfolk Probate and Family Court in 2012 following a trial before Hon. Angela M. Ordoñez. At the time, husband earned slightly less than $200,000 per year. Wife earned significantly less than this. Wife had previously served in the United States Army Reserves, but in 2004 she retired, two years short of the twenty years of service that would have entitled her to a pension. (Notably, the trial court judge found that the Wife retired due to pressure from her husband after their daughter was born with Down syndrome.)
In 2004, husband’s father established an irrevocable trust with an “open class” of beneficiaries, which is to say that husband’s father created the trust to benefit not just his children, but his grandchildren, great-grandchildren, etc. (The class of beneficiaries is referred to as “open” because new beneficiaries will be added – in the form of new grandchildren and great-grandchildren – as new generations are born. A “closed” class of beneficiaries simply means that all possible beneficiaries have been identified, and no additional beneficiaries are possible.)
The trust provided that payments to beneficiaries may be made only with the approval of both trustees, who were the husband’s brother and an independent attorney. The trust also contained a “spendthrift” provision, which stated:
[N]either the principal nor income of any trust created hereunder shall be subject to alienation, pledge, assignment or other anticipation by the person for whom the same is intended, nor to attachment, execution, garnishment or other seizure under any legal, equitable or other process.
Under the trust, the trustees alone had sole discretion over the amount, timing and frequency of all payments to beneficiaries. Of special significance was that the trust language did not create any obligation – direct or indirect – for the trustees to make payments to beneficiaries for the beneficiaries’ health, financial support, maintenance or any other specific reason. The trustees’ discretion to make payments was absolute, and the SJC held that the trustees had the authority to refuse to make payments to a beneficiary who demanded payment. In addition, the SJC held that the trustees’ duty to preserve trust assets for future generations of beneficiaries was just as great as their duty to provide support to the present, living beneficiaries.
At the time of the divorce, the trust held total assets of $24,920,217. Under the trust, the husband and his heirs (i.e. his children, grandchildren, etc.) held an 11% interest in the trust. Thus, if the husband had two children during his lifetime, and then died, then husband’s 11% interest would pass to his two children, who would split husband’s 11% interest to each receive a 5.5% interest in the trust. (If the husband ended up with eleven total grandchildren, then husband’s 11% interest would be split eleven ways, with each grandchild receiving a 1% interest upon their parents’ deaths. In this way, family trusts can end up with dozens or even hundreds of beneficiaries – each with smaller and smaller shares – as the family tree grows.)
Despite the restrictions on husband’s right to receive trust payments, both the trial court and the Appeals Court held that the husband’s interest in the trust to be included in the divorce as a marital asset subject to division. The probate court judge used a blunt (and perhaps overly simplistic) method for determining the value of husband’s trust interest; she calculated husband’s share as 11% of the $25 million in assets, or approximately $2.3 million. She then ordered husband to pay 60% of this sum to wife in 24 monthly installments to Wife of $48,699.77 per month. In consideration of these payments, the judge held that Husband would not be required to pay alimony to Wife.
A Blunt Methodology Leads to a Problematic Result
In its reversal in Pfannenstiehl, the SJC zeroed in on numerous problems with the probate court judge’s blunt calculation. The Court noted that even if husband’s “class” (i.e. husband himself, his children, grandchildren, great-grandchildren etc.) held an 11% interest in the trust, it was inconceivable that the trustees would pay all of the trust assets to a first generation beneficiary like husband, leavening nothing for future generations. The trust instrument made clear that husband’s father, who created the trust, intended the trust to benefit several generations. If the trustees paid 100% of the trust assets out to a first generation beneficiary like husband, there would be nothing left for future generations.
Further, the SJC noted that while husband received payments from the trust during the marriage, none of these payments were large enough to suggest that the trustees would ever pay a full 11% share of the assets to husband himself.
Ultimately, the Supreme Judicial Court disagreed with the decisions of the probate and family court judge and Appeals Court, holding that the value of husband’s interest in the trust was too speculative to calculate a current value, and therefore constituted a mere expectancy interest in a potential asset. As discussed extensively in our previous blog on future inheritances, the SJC noted that the Husband’s ability to receive future payments under the trust constituted a “factor” under the division of assets, where the trust contributed to the likelihood that Husband would acquire assets and income in the future. But the trust itself was excluded from the division of assets.
In its decision the SJC remarked:
Interests in discretionary trusts generally are treated as expectancies and as too remote for inclusion in a marital estate, because the interest is not “present [and] enforceable”; the beneficiary must rely on the trustee’s exercise of discretion, does not have a present right to use the trust principal, and cannot compel distributions. … [Wife] attempts to distinguish the 2004 trust from a “pure” discretionary trust, however, by noting that distributions from the 2004 trust are subject to an “ascertainable standard” which governs the trustee’s discretion.
Under § 103 of the Uniform Trust Code, an “ascertainable standard” refers to a trust provision that requires a trustee to distribute funds to support a beneficiary’s needs “relating to an individual’s health, education, support or maintenance.” … This standard limits the discretion of the trustee, who is obligated to make distributions with an eye toward maintaining the beneficiary’s standard of living in existence at the time the trust was created. …
The trustee of a trust that contains an ascertainable standard must engage in a detailed inquiry into each beneficiary’s needs and finances, and must “give serious and responsible consideration both as to the propriety of the amounts and as to their consistency with the terms and purposes of the trust.” Much consideration must be “viewed in light of [the beneficiaries’] assets and needs, when measured against the assets of the trust”. [Citations omitted.]
In essence, the Wife in Pfannenstiehl argued that because the trust obligated trustees to make payments to beneficiaries, based on each beneficiary’s financial needs, that it was not a true “discretionary trust”. In other words, Wife argued that the trustees were ultimately required to make payments to the Husband based on the Husband’s financial needs, even if they could delay and control the payments.
The SJC rejected Wife’s argument, holding that where Husband was “one of eleven living beneficiaries among an open class of beneficiaries”:
The trustees of the 2004 trust are required to take into account the trust’s long-term needs and assets, unpredictability in the stocks that fund it (which the judge found at times in the past have provided no income or have incurred a loss), the changing needs of the eleven current beneficiaries, and the possibility of additional beneficiaries. [Husband’s] present right to distributions from the 2004 trust is speculative, because the terms of the trust permit unequal distributions among an open class that already includes numerous beneficiaries, and because his right to receive anything is subject to [the trustee’s discretion]. [Citations omitted].
In the end, the SJC affirmed a long-standing general rule that would have been dramatically altered if the Appeals Court decision had been allowed to stand:
Interests in discretionary trusts generally are treated as expectancies and as too remote for inclusion in a marital estate, because the interest is not “present [and] enforceable”; the beneficiary must rely on the trustee’s exercise of discretion, does not have a present right to use the trust principal, and cannot compel distributions.
Although the SJC did not foreclose the possibility that some interests in discretionary trusts could be divided as assets, the decision makes clear that in most cases, such interests are excluded from division in a divorce.
Spendthrift Clauses: Not Determinative, but the Trust Maker’s Intent Matters
Notably, in its Pfannenstiehl decision, the SJC held that the trust’s spendthrift clause – which provided that no interest of a beneficiary may be assigned to a third party by a court – was not enough, on its own, to prevent a beneficial interest in trust to be divided as a marital asset. For example, if a spouse had a guaranteed interest in trust – or a guaranteed right to demand trust benefits from a trustee – then a spendthrift clause may not prohibit division in a divorce. That said, the SJC decision affirms the principle that if a trust maker (testator) does not want trust assets to be assigned to a former spouse in a divorce, then the testator can draft a trust that avoids the division of assets in a beneficiary’s divorce.
Ensuring that trust benefits are excluded from the division of assets requires the testator to take a variety of protective measures:
- Include a spendthrift clause prohibiting the assignment of trust assets to any third parties, including a beneficiary’s former spouse in a divorce.
- Grant absolute discretion to trustees to determine when, how much, and whether beneficiaries receive payments under the trust.
- Create an open class of beneficiaries (i.e. future generations/heirs) so that trustees are obligated to preserve trust assets for future generations.
- Avoid including an “ascertainable standard”, such as a requirement that trustees make payments to beneficiaries “relating to an individual’s health, education, support or maintenance”, where a beneficiary’s spouse could argue that such a standard requires a trustee to make payments to a beneficiary upon demand.
In short, a determined testator should be able to protect trust assets from division in the divorce of a beneficiary with carefully crafted language that elevates the protection of the overall trust estate over the rights and/or needs of any single beneficiary.
Could the Probate Court Judge have Divided the Pfannenstiehl Trust Using Another Method?
The SJC decision was especially critical of the probate court judge’s decision to value Husband’s present interest in the trust at 11% of the total trust assets of $25 million. This method seemed to ignore the fact that husband would never actually receive 11% of the total trust property from the trustees, since doing so would effectively drain the trust of asset for any future generations. (Moreover, even if husband somehow did receive the full 11% interest over his lifetime, the probate court judge’s decision to make husband pay 60% of this sum in just two years seemed especially onerous.)
A more logical method of dividing husband’s interest would have been to assign a percentage of husband’s trust benefits to wife on an “if and when received” basis. Under this method, wife would receive 60% of any payment husband received from the trust, if and when such payments were actually received by husband. At a minimum, this method would ensure that wife would only receive payments for monies husband actually received. An “if and when received” method would have resulted in periodic payments to Wife over time that would have been similar in several ways to alimony.
We will never know if an “if and when received” division of husband’s trust interest would have survived appeal. What is clear is that the blunt, simplistic assignment of a lump sum value to husband’s amorphous interest forced the SJC to act. A more nuanced approach by the probate court judge that blended elements of alimony and installment payments would have given the SJC far more room to uphold the decision.
Not a Divisible Asset, but Still a Factor in Asset Division and Alimony
In its reversal, the SJC made clear that even if the trust benefits were not a divisible asset, the husband’s ability to receive trust benefits would be a factor in the division of the parties’ remaining assets under G. L. c. 208, § 34:
Considering the language of the 2004 trust, and the particular circumstances here, the ascertainable standard does not render [husband’s] future acquisition of assets from the trust sufficiently certain such that it may be included in the marital estate under G. L. c. 208, § 34. As noted, however, the trust may be considered as an expectancy of future “`acquisition of capital assets and income’ in determining what disposition to make of the property that [i]s subject to division.” (Citations omitted.)
Under G. L. c. 208, § 34, a court may consider an expectancy interest in the factors the court uses to determine an equitable division of the marital estate. One such factor is opportunity of each spouse for future acquisition of capital assets and income. Since husband has this expectancy in the trust, which is now not being divided, the SJC indicated that the interest may skew the division of the actual assets in wife’s favor, as the trusts adds to husband’s opportunity to acquire future capital. Husband is likely in the future to acquire assets from the trust, and a court can use this future opportunity to rationalize an equitable but not necessarily equal division of the assets that currently exists in the marriage. Check out my previous blog for a more on this issue.
In Pfannenstiehl, the parties held assets other than the trust of $2.1 million. With the case remanded to the probate court for further trial, you can be sure that wife will receive a larger share of the $2.1 million in assets in consideration of the likelihood that husband will continue receiving benefits under the trust. Moreover, on remand, the probate court judge is likely to order husband to pay alimony to wife, with the husband’s receipt of trust monies used as a source of alimony to wife.
About the Author: Nicole K. Levy is a Massachusetts divorce lawyer and Massachusetts family law attorney for Lynch & Owens, located in located in Hingham, Massachusetts and East Sandwich, Massachusetts. She is also a mediator for South Shore Divorce Mediation.