Trust Funds – How Are They Split in a Divorce?
A legal “trust” is a concept that many people may have heard about, but few will truly understand, especially in connection with a divorce involving someone who is a trust beneficiary.
Simply put, a “trust” relationship arises when property rights initially held by one person (the donor) are transferred to another person (the trustee), who holds them for the benefit of a third person (the beneficiary or “donee” of the trust). Experienced Family Law lawyers may use a trust arrangement in many different and creative scenarios, most often to save their clients income taxes or asset disposition costs.
The net effect of a basic trust arrangement is that the beneficiary obtains a right to an asset or asset-generated income that is held and managed by another person. To use an easy scenario: Wealthy older parents may want to give their adult children access to significant funds, but not hand over the money outright for fear that it will be squandered. Rather than gift their children large sums of money – which may also have tax and other consequences – the parents may set up a legal trust that transfers the money to a third party trustee (e.g. a friend of the family) who holds and invests it for the benefit of the adult children (as beneficiaries).
With the trustee in charge of the investing and managing, the capital of the trust fund generates interest income that gets distributed to the beneficiaries. A trust of this type would usually be structured so that the capital remains untouched but any earned interest is paid out by the trustee to the adult children on a certain pre-set schedule, or on the happening of a specified event (such as the beneficiary turning a certain age).
This means that the adult children have a clear legal right to the interest generated by the trust fund, even though it is technically in the hands of the third-party family friend, for their benefit.
But what happens if the adult children decide to divorce their spouses? How as the legal rights in the trust fund accounted for in the inevitable asset-valuation and equalization exercise?
In Ontario – where the definition of “property” in the Family Law Act is very broad – the courts have made it clear that an interest in either the capital or in the income generated by a trust, constitutes an asset capable of being included in a spouse’s Net Family Property for the purposes of equalization. This broad category includes both personal property and also land, and also encompasses trust capital and any income that has been generated. Moreover, to constitute “property” the interest can be either vested or contingent on a future triggering event; it can be either a present interest or one that arises in the future (for example, an interest in future income generated from the capital of the trust).
So to apply this legal jargon to our trust fund example: The adult children’s rights in relation to the interest accrued by the trust fund (as a result of the trustee’s investment efforts) would be considered “property” for the purposes of calculating Net Family Property for equalization. Generally speaking, it gets accounted for and divided like any other matrimonial asset.
But putting a dollar-value on that legal interest is often difficult to do. Trust-based interests are not commercially marketable or transferrable, and tend to be indeterminate in nature (i.e. they can arise in the future or only after certain contingencies). The nature of the trust’s capital and the beneficiaries’ own lifespan will also be a consideration, as will the mathematical method used to arrive at a dollar-amount. Plus, while in many cases the trustee’s investment and distribution duties are well-defined, in others instances the trustee is given full discretion and liberty to invest, deal with or distribute trust income or property as he or she sees fit. Or, the trustee may have a duty to distribute at certain points, but may have discretion as to how much the beneficiaries receive.
Needless to say the issue is complex; a beneficiary’s interest in the trust fund (or the income generated by it) will depend on many factors. If you are in the fortunate situation to be the beneficiary of a trust and have concerns over how it might be dealt with in a divorce, make sure to obtain advice from an experienced Family Law specialist.