Can a Trust Protect Property from Divorce or Bankruptcy?

Parents often spend years building up property and other assets they hope will benefit their children. The difficult decision can be how to pass that wealth on without completely giving up control over what happens to it afterwards. If a property is gifted outright and the child later divorces or becomes bankrupt, the parent cannot simply take the gift back because circumstances have changed.

A discretionary trust offers another way of passing wealth to the next generation while retaining more control over when and how a beneficiary receives it.

How does a trust differ from an outright gift?

With an outright gift, ownership passes directly to the recipient, who can usually decide what happens to the property from that point onwards. If they later become bankrupt, their beneficial interest may form part of the bankruptcy estate and become available to creditors.

A discretionary trust works differently because trustees hold and manage the assets for potential beneficiaries. Beneficiaries do not normally have an automatic right to demand a particular asset or payment, as the trustees decide whether distributions should be made and how much should be provided.

Can a trust protect assets if a beneficiary becomes bankrupt?

A properly structured discretionary trust can offer greater protection where a beneficiary later becomes bankrupt. If they have no fixed entitlement to the trust property, there may be no specific trust asset for the trustee in bankruptcy to claim.

How and when the trust was created can also become important if financial difficulties already existed. Transfers made once financial problems are known can be challenged under insolvency law in certain circumstances, so moving assets into trust once creditors are already pursuing payment can create significant problems.

A discretionary trust is therefore more effective as part of early family and estate planning than as a reaction to financial trouble that has already begun.

What happens to trust assets on divorce?

Trusts can also provide a degree of protection where a beneficiary later divorces, although the position is less straightforward than in bankruptcy.

When dealing with finances on divorce, the court can consider the wider financial resources available to each party, and certain trusts may become relevant when assessing that position. How the trust has operated during the marriage can also influence how it is viewed.

For example, a beneficiary who has regularly received substantial distributions whenever requested may appear to have greater access to the trust than somebody who has received occasional payments at the independent discretion of the trustees.

The court can therefore look beyond the trust paperwork and consider how the arrangement has worked in real life.

When might a trust be worth considering?

A trust may be worth considering where families want to pass substantial assets to the next generation while retaining some control over how and when they are accessed. Anyone considering a trust because of an existing bankruptcy, creditor claim or divorce should take legal advice before transferring property.

mlplaw’s Private Client team can advise on trusts, lifetime gifting and estate planning.