When You Definitely Need a Trust, Part 1: Protecting Your Kids' Assets From Divorce

When your net worth is on the lower end of the spectrum, it may not make much sense to create a trust. You can often create feasible, low-cost workarounds for avoiding probate, as I outlined here: https://www.pihlfinancialplanning.com/post/do-you-need-a-revocable-trust-to-avoid-probate-on-your-house

However, as your net worth increases, it becomes more and more advantageous to have a trust in place. The disadvantages of higher cost and complexity start to matter less, and the advantages become more potent. 

Having a trust becomes a no-brainer particularly when you want to prioritize asset protection. After all, there are many risks to your assets, many of which may arise after you are gone. 

It’s not only that your heirs might spend it recklessly, though this is an important consideration to think through. Consider also the risks that threaten their assets. For instance, divorce and lawsuits. 

Often, people think that leaving assets to their kids in a graduated fashion (or in a series of large installments) will protect that nest egg. Since they don’t receive the full amount all at once, they get to learn how to make the later installments last longer. And that’s at least somewhat true. 

However, if your kid gets divorced at 41, does it really help them to wait until 40 to receive those assets? 

Many states offer some protection for inherited assets in the case of divorce, however, there are several ways to run afoul of these protections. For instance, if distributions are made to a joint account, or to cover joint expenses for the household, a court might reasonably rule that those inherited assets are now “marital property,” NOT the property of your son or daughter. 

Or if the assets are used to purchase a home, particularly if the home is held in both spouse’s names, the home would likely be a marital asset and get split evenly in a divorce. Is it your intent to buy your kid’s ex-spouse half a home? Honestly, I’ve met families who wouldn’t have any problem with that, but they are the strange and beautiful exception. And even in those cases it’s FAR better to be intentional than to let it happen by accident. 

Or what about alimony? In calculating the financial resources available to the couple, if there’s any kind of regular income coming from the trust to your kid, that could easily get counted in calculations of “what’s fair” in a divorce. So now your kid has lost half or all of the income coming from the trust, effectively negating the value of all the principal because their ex-spouse is spending the only part that can be spent. 

All of this can be avoided with proper trust design and administration. It tends to be slightly more expensive, but once your assets are in the $2,000,000 to $10,000,000 range, it really becomes a no-brainer.