Interests in Trusts as Marital Property in Divorce
© 2004 National Legal Research Group, Inc.
One of the most important and flexible devices used to make conditional transfers between persons, particularly in the testamentary context, is the equitable trust. Because trusts are used for such a variety of different purposes, they pose unique challenges for courts classifying and dividing property upon divorce. When trusts are used for the same general purpose as a gifts or inheritances, they tend to be given similar treatment. But trusts are sometimes used for other purposes as well, and in those contexts the end result of the cases is very different. This article will briefly review some of the leading concepts and cases involved in classifying and dividing interests in trusts. For a more detailed treatment, see Brett R. Turner, Division of Trusts in Divorce Cases, 15 Divorce Litigation 85 (May 2003).
The first requirement in the definition of marital property, of course, is that the interest in question constitute "property." Certain types of interests, including most importantly educational degrees and the expectancy of receiving a future gift or inheritance, are not divisible upon divorce because they do not qualify as "property" to begin with. See, e.g., In re Marriage of Graham, 194 Colo. 429, 574 P.2d 75 (1978) (educational degree); Rubin v. Rubin, 204 Conn. 224, 527 A.2d 1184 (1987) (expectancy of gift or inheritance). See generally Brett R. Turner, Equitable Distribution of Property 6.20, 6.27 (2d ed. 1994 & Supp. 2003).
In some situations, a trust may resemble the expectancy of a future inheritance. The resemblance is very strong when the trust is revocable, for a revocable trust does not guarantee the beneficiary enforceable ownership of anything. So long as the settlor retains the power to revoke the trust, the beneficiaries' interests exist only at the settlor's sufferance. Because of this fact, the general rule is that the beneficiaries' interests in revocable trusts do not constitute property. Rubin. Rather, the assets of a revocable trust are treated as if owned by the settlor. An unconditional power to revoke the trust is generally equivalent to actual ownership of the trust assets. E.g., In re Marriage of Seewald, 22 P.3d 580 (Colo. Ct. App. 2001) (classifying individual assets of revocable trust); Galachiuk v. Galachiuk, 262 A.D.2d 1026, 691 N.Y.S.2d 828 (1999) (where husband failed to prove that trust was irrevocable, proper to divide trust assets between the parties); In re Estate of Knickerbocker, 912 P.2d 969 (Utah 1996) (for purposes of equitable distribution, assets of a revocable trust are owned by the settlor).
When a trust is irrevocable, the enforceability of the beneficiaries' interests does not depend upon the whim of the settlor. In some situations, however, the right of an income beneficiary to receive distributions from the trust may depend upon the discretion of the trustee. These spendthrift provisions are often created for the purpose of limiting the beneficiary's power to spend the trust income unwisely. Where the right to receive income depends entirely upon the discretion of the trustee, so that the beneficiary has no enforceable right to demand any particular amount of income, an income interest in a trust is not property. E.g., In re Marriage of Jones, 812 P.2d 1152 (Colo. 1991); Hawkins v. Hawkins, 11 Conn. App. 195, 526 A.2d 872 (1987); In re Marriage of Eddy, 210 Ill. App. 3d 450, 569 N.E.2d 174 (1991).
A discretionary income interest is not property even where the trustee is actually giving substantial amounts to the income beneficiary, so long as the right to receive those amounts is not legally enforceable. In Hawkins, for example, the trustee regularly gave the wife $30,000 per year in trust income. The court nevertheless held that the right to receive future payments was not property, as the wife had no enforceable right to receive any amount at all. If the trust were to choose in the year after the divorce to give the wife nothing, the wife would have no legal right to contest that decision.
A mandatory income interest, requiring the trustee to distribute income to one or more beneficiaries, does constitute property. E.g., Sayer v. Sayer, 492 A.2d 238 (Del. 1985); In re Becker, 122 Or. App. 567, 858 P.2d 480 (1993). Considerable uncertainty may exist in the amount of income which the trust actually produces, but that uncertainty does not prevent the income interest from constituting property, so long as the beneficiary has a legally enforceable right to a stated amount or percentage of whatever income is generated. For example, if the husband's mother places Blackacre in an irrevocable trust, with the income to be divided equally between the husband and his sister, the husband's income interest constitutes property, even if the actual amount of income which Blackacre produces per year has traditionally varied widely. The uncertainty in amount is a major factor in valuation and division, but it does not affect classification.
One of the most difficult questions involved in classifying interests under an irrevocable trust is determining whether a remainder interest constitutes property. A remainder interest, of course, is the right to receive a portion of the trust corpus after the trust terminates.
The fundamental problem with classifying remainder interests is that their level of certainty varies greatly from case to case. For example, assume that the wife's father devises his property into an irrevocable trust, with the income payable to the wife's mother for life, and the remainder payable upon the mother's death to the settlor's children. At the time of the divorce, the father has died, the mother is age 50, the wife is age 25, and she has a brother who is age 28. This is a very common and simple form of trust, yet the certainty of the remainder depends greatly upon the facts. If the wife's mother is terminally ill, the remainder will be highly certain. If the wife is terminally ill, the remainder will be highly uncertain. If all parties are in normal health for their ages, it seems likely that the wife will eventually receive something, but the time of receipt depends greatly upon the lifespan of the mother, who could live for several decades.
The law clearly needs some sort of rule for determining when a remainder interest is too speculative to constitute property. A majority of the existing cases have adopted the common-law distinction between vested and unvested remainders. Where the remainder is vested, it is deemed sufficiently certain to constitute property. See, e.g., In re Marriage of Gorman, 36 P.3d 211 (Colo. Ct. App. 2001) (fact that remainder is subject to divestment on future conditions does not change the result); Dietter v. Dietter, 54 Conn. App. 481, 737 A.2d 926 (1999); In re Marriage of Tatham, 173 Ill. App. 3d 1072, 527 N.E.2d 1351 (1988); Moyars v. Moyars, 717 N.E.2d 976 (Ind. Ct. App. 1999); Lauricella v. Lauricella, 409 Mass. 211, 565 N.E.2d 436 (1991); In re Marriage of Foreman, 294 Mont. 181, 979 P.2d 193 (1999) (even though remainder was subject to divestment if husband died at an early age); Flaherty v. Flaherty, 138 N.H. 337, 638 A.2d 1254 (1994) (despite antiassignment clause); Lawrence v. Lawrence, 100 N.C. App. 1, 394 S.E.2d 267 (1990); Zuger v. Zuger, 563 N.W.2d 804 (N.D. 1997); In re Marriage of Taylor, 121 Or. App. 635, 856 P.2d 325 (1993); In re Becker, 122 Or. App. 567, 858 P.2d 480 (1993); Chilkott v. Chilkott, 158 Vt. 193, 607 A.2d 883 (1992); Trowbridge v. Trowbridge, 16 Wis. 2d 176, 114 N.W.2d 129 (1962).
Conversely, where the remainder is unvested, it is deemed too speculative to constitute property. See, e.g., In re Marriage of Hoffman, 493 N.W.2d 84 (Iowa Ct. App. 1992); Williams v. Massa, 431 Mass. 619, 628-29, 728 N.E.2d 932, 940-41 (2000) (husband's contingent remainders were "mere expectancies, comparable to a future inheritance, which are not sufficient property interests to be considered a part of the marital estate"); In re Marriage of Beadle, 291 Mont. 1, 968 P.2d 698 (1998); Storm v. Storm, 470 P.2d 367 (Wyo. 1970).
The use of vesting as the dividing line between certain and speculative remainder is common. But the common practice makes little sense. The distinction between vested and unvested remainders has a long history in the law of trusts and real property. It depends upon distinctions which may have made sense in earlier times, when applying different rules of law, but which bear little relevance to the division of property in modern divorce cases.
A few simple examples demonstrate the point. Consider the above example: a life estate in the wife's 50-year-old mother, followed by a remainder in the 25-year-old wife and her 28-year-old brother. If the trust document names the wife and her brother by name, or creates a remainder in children living at the time of the settlor's death, the remainders are vested under the common-law rule, subject to divestment if the wife dies before her mother. E.g., Disney v. Wilson, 190 Va. 445, 57 S.E.2d 144 (1950). The wife's remainder is therefore property, even if she is terminally ill and unlikely to ever receive anything. Conversely, if the trust document creates a remainder in the settlor's children living at the time of the life tenant's death, the remainder is unvested at common law until the mother actually dies. E.g., Smoot v. Bibb, 124 Va. 28, 97 S.E. 355 (1918). The wife's interest is therefore not property, even if the mother is terminally ill and the receipt of benefit is almost certain.
The presence of a terminal illness is admitted as an unusual fact. But the same problems are present even without a terminal illness. Since the wife will probably outlive her mother, it is not unreasonable to hold that the wife's remainder in this situation does constitute a form of property. As noted above, the law will treat the remainder as vested where the wife and her brother are named in the trust document, or where the members of a class of beneficiaries (here, the settlor's children) are determined at the settlor's death. In exactly the same fact situation, however, the remainder becomes unvested, and therefore would not constitute property, if the trust document determines the class members only upon the life tenant's death.
Regardless of what language the trust document uses, however, the ultimate allocation of the remainder is the same: The wife receives value only if she survives her mother. Under the common-law rule, therefore, the crucial point is not the certainty or speculativeness of the wife's interest, but rather the precise word choices made by the drafter of the trust document.
Moreover, the difference in wording between vested and unvested remainders is often very slight. For instance, a remainder "to my children living at my death" would be vested, subject to divestment, while a remainder "to my children living at my wife's death" would be unvested until the death of the settlor's wife (the wife's mother in our hypothetical divorce case). The addition of the single word "wife's" to the language of the trust document has converted the remainder from vested to unvested, and therefore under the majority rule from property to not-property, even though the actual distribution of value from the trust is exactly the same in both instances.
Regardless of whatever policy reasons remain for drawing this sort of hairline distinction under the law of trusts and real property, there is little reason to draw the distinction under the law of equitable distribution. The important point under the latter law is whether the remainder is certain or speculative. The technical status of the trust interest as vested or unvested often bears no significant relationship to the actual speculativeness of the interest.
A minority of cases avoid the vesting problem by holding that all remainders, vested or unvested, constitute property. See Van Oosting v. Van Oosting, 521 N.W.2d 93 (N.D. 1994); In re Bentson, 61 Or. App. 282, 284-85, 656 P.2d 395, 396 (1983) ("Whether vested or contingent, husband's interest in the trust is a marital asset to be considered in the division of marital property"); Chilkott v. Chilkott, 158 Vt. 193, 607 A.2d 883 (1992). These cases are an improvement upon the majority rule, but they seem to permit the division of even the most speculative remainders. For example, a remainder in an 80-year-old grandmother, vesting only if she survives her infant grandson, would to all indications still be property. The difficulties associated with the issue of vesting are a questionable basis for discarding the entire notion that some interests are too speculative to constitute property.
A Better Approach: D.L. v. G.L.
Case law on the speculativeness of remainders is divided between an unwise majority rule which relies upon an archaic distinction, and a somewhat less unwise minority rule which draws no distinction at all. Clearly, there is need for a third approach. Such an approach should retain the basic concept of a distinction between certain and speculative interests, but base the distinction upon firmer ground than the arcane common-law concepts of vested and unvested remainders.
Fortunately, one very recent case shows clear movement toward such a third approach. In D.L. v. G.L., 61 Mass. App. Ct. 488, 811 N.E.2d 1013 (2004), the issue was classification of the husband's interests in seven different trusts. Since Massachusetts is an all-property state in which the concept of separate property is not recognized, the divisibility of the husband's interests depended upon whether they constituted property.
With regard to various interests in income and principal which were dependent upon the discretion of the trustee, the court held, in accordance with the cases cited above, that those interests were not property. Even though consistent distributions of income to the husband had been made, the court still held that the distributions were properly treated as income for alimony and not as an interest in the nature of property, where the right to receive payments was entirely dependent upon the trustee's discretion.
The trial court also held that the husband's remainder in one additional trust did not constitute property. The wife argued on appeal that the trial court erred, because the husband's remainder was vested. After noting that the wife's proposed findings of fact in the trial court recognized that the remainder was unvested, the court continued:
That aside, there is substantial authority to indicate that the husband's remainder interest is, in fact, contingent in nature as it is subject to conditions precedent, including an express condition of survivorship. . . . However, even when a party's remainder interest in a trust cannot strictly be characterized as vested, it still may be included, in appropriate instances, within the marital estate. See S.L. v. R.L., 55 Mass.App.Ct. at 881, 884, 886-887, 774 N.E.2d 1179. Cf. Baccanti v. Morton, 434 Mass. at 794-795, 752 N.E.2d 718, and cases cited ( 34, defining "nonvested benefits, rights and funds" as part of a party's estate, clearly indicates that vesting during the marriage is not a requirement). As we have observed, judges are not bound by wooden concepts of title or property, but consider whether future acquisition of assets is "fairly certain."
61 Mass. App. Ct. at 499-500, 811 N.E.2d at 1025 (emphasis added). The court added in a footnote that just as a contingent or unvested interest can sometimes constitute property, so can a vested interest sometimes not constitute property:
Conversely, there is suggestion in cases such as Lauricella v. Lauricella, 409 Mass. at 216, 565 N.E.2d 436, that even when a remainder interest is determined to be vested, a court will closely scrutinize the particular circumstances of each case. In Lauricella, the court found that the husband had a vested right to certain trust property, "subject to divestment only if [the husband did] not survive until the trust terminate[d] according to its terms." The court took careful note that the husband was "only about twenty-six years old, [and] the likelihood is that he will survive [the roughly eighteen years required] to receive his share of the title." Ibid.
61 Mass. App. Ct. at 500 n.17, 811 N.E.2d at 1025 n.17 (emphasis added). The court was clearly evaluating the degree of speculativeness to which the remainder was subject, but it rejected the mechanical use of the common-law vested/unvested distinction as the sole criterion for making the evaluation. This is a material improvement in the law on the classification of remainder interests under the law of equitable distribution.
The general test of speculativeness adopted by the court, in place of the common-law vesting requirement, was "whether future acquisition of assets is 'fairly certain.'" 61 Mass. App. Ct. at 499-500, 811 N.E.2d at 1025 (emphasis added). While the court did not expressly quote to any particular source for the key phrase "fairly certain" in the above quotation, the court previously referred to the following passage from one of the leading Massachusetts Supreme Judicial Court cases on the division of interests in trusts:
This court is not bound by traditional concepts of title or property in considering what constitutes a party's "estate" for purposes of 34, and we have held a number of intangible property interests to be subject to division. See Lauricella v. Lauricella, 409 Mass. 211, 214, 565 N.E.2d 436 (1991), and cases cited. When the future acquisition of assets is fairly certain, and current valuation possible, the assets may be considered for assignment under 34. Compare Dewan v. Dewan, 399 Mass. 754, 757, 506 N.E.2d 879 (1987) (nonvested pension rights part of marital estate), with Drapek v. Drapek, 399 Mass. 240, 244, 503 N.E.2d 946 (1987) (potential future earnings not marital asset).
Williams v. Massa, 431 Mass. 619, 628, 728 N.E.2d 932, 940 (2000).
While the above passage did use the phrase "fairly certain" to describe the level of certainty needed for an interest to constitute property, it is questionable whether Williams as a whole should be read to adopt "fairly certain" as the standard. The Williams court stated its central holding as follows:
The husband's contingent remainder interests in the two trusts were not clearly fixed and enforceable property rights. See Hanify v. Hanify, 403 Mass. 184, 193, 526 N.E.2d 1056 (1988) (Liacos, J., concurring in part and dissenting in part) ("A final and equitable property division under 34 should not be based on speculative assets"). These interests were mere expectancies, comparable to a future inheritance, which are not sufficient property interests to be considered a part of the marital estate.
431 Mass. at 628, 728 N.E.2d at 940-41. This passage does not use the phrase "fairly certain," but rather uses a number of different phrases to set forth the standard. The first phrase, "clearly fixed and enforceable," is higher than the "fairly certain" standard. Since Massachusetts divides interests such as unvested retirement benefits and unvested stock options, neither of which are necessarily "clearly fixed" at all, the court cannot have used that standard with the intent to state a precise test. The second phrase, "not . . . speculative," is reasonable in theory, but it is probably too vague for consistent application.
The best phrase overall is the third one: "mere expectancies, comparable to a future inheritance." "Expectancies" is no more definite than "speculative," but the express comparison to a future inheritance adds considerable substance to the test. Future inheritances are one of the types of interests most commonly held not to be property. By noting that the contingent remainders at issue were speculative to a nature and degree "comparable" to future inheritances, the court suggested that comparison to future inheritances should be a key part of the test.
Use of future inheritances as a comparative standard for speculativeness logically explains why Massachusetts treats some interests as property but not others. For example, unvested retirement benefits are not at all like future inheritances, because the pension holder has an enforceable legal right to collect benefits if the conditions are met. Indeed, pages of federal legislation have been enacted to make certain that companies fund their retirement plans sufficiently to meet foreseeable obligations. Unvested stock options likewise give the owners enforceable rights. Moreover, and in some ways most importantly, unvested retirement benefits and unvested stock options are clearly treated as a salary substitute by employers and employees bargaining at arm's length in the marketplace. Expected inheritances are not usually the subject of actual arm's-length bargaining.
"Fairly certain," by contrast, does not explain the results of cases dealing with interests other than contingent remainders. Unvested pensions are often not "fairly certain," particularly when an employee has only a short work history or the financial health of the employer is questionable. Unvested stock options depend not only on the financial health of the employer, but also upon the likelihood that the employer's stock price will exceed the strike price of the option before the option expires. In a period of decline in the stock market, many options produce little or no value. Yet unvested retirement benefits and stock options are always treated as property in Massachusetts. See Baccanti v. Morton, 434 Mass. 787, 752 N.E.2d 718 (2001); Dewan v. Dewan, 399 Mass. 754, 506 N.E.2d 879 (1987).
In both the pension and stock option situations, the uncertainty of the benefits at issue can be handled equitably simply by dividing the benefit on a deferred percentage basis, requiring the owner to pay the nonowner a stated percentage of any funds which ultimately are received. In theory, speculative remainders could be divided in the same way. The reason why contingent remainders are not so divided is as much the uncertainty of the benefit as the facts that speculative remainders do not yield legally enforceable rights, and that they are not commonly treated as a cash substitute in the workplace. In short, they are not at all like the expectancy of a future inheritance.
Applying the law to the facts, the D.L. court held that the remainders at issue were too speculative to be divided:
Here, we think the husband's remainder interest in the 1922 Trust is "too remote or speculative" to be included within the marital estate. While we are cognizant that certain conditions of survivorship might not be a bar to the inclusion of a trust interest within the marital estate, see, e.g., Lauricella v. Lauricella (discussed in note 17, supra); Davidson v. Davidson, 19 Mass.App.Ct. at 371-372, 474 N.E.2d 1137 (remainder interest of husband, who was thirty-three years of age at the time of divorce, would be distributed free of trust when his mother [then living] died and he attained the age of thirty-five); S.L. v. R.L., 55 Mass.App.Ct. at 884, 774 N.E.2d 1179 (wife's interests in trusts subject only to her surviving her mother), the husband's interest in the present trust is conditioned not only upon his survival to April 10, 2011, but upon his father's death by that date. At the time of trial, the husband's father was sixty-seven years of age. (The parties point to no evidence concerning his health.) Unlike the circumstances in Lauricella, it cannot be said on this record that there is a "likelihood," much less a fair certainty, that the husband's father will not be alive on April 10, 2011, and the husband will be alive on that date.
61 Mass. App. Ct. at 500-01, 811 N.E.2d at 1026. In short, the key point was that the husband's benefit depended not only upon his survival, but also upon the death of his 67-year-old father before April 10, 2011. The presence of a dual survivorship requirement, with no evidence presented on the father's health apart from his mere age, was the crucial fact.
While similarity to a future inheritance is a better test for speculativeness than the general phrase "fairly certain," D.L. still took a major step forward by abandoning the mechanical use of the vesting distinction. The application of the law to the facts, focusing upon the existence of a dual survivorship requirement, is not unreasonable. If future courts base their decisions upon the actual degree of certainty or speculativeness involved, the results will almost certainly be better than the results reached through blind reliance upon ancient rules of trust and real property law for classifying remainders as vested or unvested.
Remainders As Marital Property
Where a trust interest constitutes property, it is subject to division in all-property states like Massachusetts. In dual-classification states, an additional requirement must be met: The trust interest must be marital property.
Since most trust interests are acquired by gift or inheritance, they often qualify as separate property. E.g., Mason v. Mason, 319 Ark. 722, 895 S.W.2d 513 (1995) (inherited trust); Pittman v. Pittman, 791 So. 2d 857 (Miss. Ct. App. 2001) (gifted trust). Income from a separate property trust interest could be marital property in states which treat income from separate property as marital. But see Friebel v. Friebel, 181 Wis. 2d 285, 510 N.W.2d 767 (Ct. App. 1993) (since holder of income interest did not own the trust itself, trust income was not income from separate property owned by a party, but rather a distinct gift from the settlor, and therefore not marital property). Likewise, active appreciation in a separate property trust could be treated as marital property. E.g., In re Marriage of Tatham, 173 Ill. App. 3d 1072, 527 N.E.2d 1351 (1988); In re Marriage of Schatz, 768 S.W.2d 607 (Mo. Ct. App. 1989). Note, however, that income from or appreciation in a trust interest would not be marital property where the interest is not property to begin with. See In re Marriage of Jones, 812 P.2d 1152 (Colo. 1991) (income from nonproperty trust interest is not marital property).
While trust interests are often acquired by gift or inheritance, this is not universally true. In particular, trusts created by the parties themselves are acquired in exchange for the property used to create them, and are therefore marital property to the extent that they were created with marital contributions. E.g., Heinrich v. Heinrich, 609 So. 2d 94 (Fla. Dist. Ct. App. 1992); Findlen v. Findlen, 695 A.2d 1216 (Me. 1997); Caccamise v. Caccamise, 130 Md. App. 505, 747 A.2d 221 (2000); Fox v. Fox, 1999 ND 68, 592 N.W.2d 541 (N.D. 1999). Trust interests are separate property, of course, to the extent that they were created with separate contributions. E.g., Schmanski v. Schmanski, 115 Nev. 247, 984 P.2d 752 (1999).