Protecting Your Child’s Inheritance if They Get Divorced

Reviewed by Harry Margolis, a Boston-based elder law attorney and FreeWill Fellow

Are you a bit uncertain that your son or daughter married the wrong person and what you leave them will someday be split with their ex-spouse? Even if you don’t second-guess their choice, are you concerned that they won’t manage their money well? Or if your child dies first, that their inheritance will eventually land in the hands of your son- or daughter-in-law’s next spouse, rather than going to your grandchildren? If so, this guide is for you.

How can you protect your child’s inheritance in the event of divorce?

You can ensure your child's inheritance is protected by leaving it in a trust, rather than giving the inheritance to them outright. This step protects whatever they leave to children from divorce, creditors and happenstance. In short, a trust keeps it in the family.

These asset-protection trusts come under several names: "generation skipping," "spendthrift," "asset protection," or "dynasty" trusts. In our practice, we call them "family protection" trusts, since that's their purpose.

Creating a family protection trust is a favor you can do for your children and grandchildren, and it’s a step they cannot take for themselves. Traditionally, individuals have not been able to create trusts for their own benefit and still have the assets protected from their creditors and spouses. Many states have changed these rules to permit so-called “self-settled” asset protection trusts, but they don’t necessarily provide divorce protection and they can be expensive to set up.

On the other hand, the law has always permitted third parties - in this case, parents - to create trusts that are protective of the trust assets for beneficiaries. So, why doesn’t everyone create family protection trusts? The answer is that there are a few strings attached and potential costs.

Drawbacks of Asset Protection Trusts

• The beneficiaries cannot have the right to withdraw the trust funds; distributions of principal must be at the discretion of the trustee.
• The trusts are most protective if they have an independent trustee. If that’s a bank or trust company, there will be an annual charge.
• The trust must file an annual tax return, though it doesn’t pay any tax if all the income earned is distributed each year.

That’s about it. Thus, the main issue is whether the loss of control for the beneficiaries is worth the added protection. Where you fall in balancing these elements may well depend on your own circumstances and the situation of the beneficiaries. Any difficult situations you or your family members may have faced in the past will likely influence whether you choose the protections of a trust for your children and grandchildren.

Learn more:

• Living Trusts, Explained
• Family Trusts, Explained
• Revocable Vs Irrevocable Trusts