What is an Alimony Substitution Trust

When a spouse is ordered to pay alimony after a divorce or separation, it doesn’t always have to be paid in cash, especially if assets are tied up in stocks or rental property. In this case, an alimony substitution trust can be set up and funded to meet the financial terms of a final settlement.

BREAKING DOWN Alimony Substitution Trust

An alimony substitution trust is a bank account that is managed by a trustee (person or institution) who holds a legal title enabling them to manage trust funds for the benefit of the beneficiary. The money held in this trust is referred to as trust money. This trust agreement ends when the obligation to pay the ex-spouse ends. Payments made from these trust accounts are made automatically and periodically as long as there are enough funds or assets in the trust to cover such spousal support payments.

For example, the spouse that must pay alimony can put income-generating investments or equity from a business into a trust for the recipient spouse, who also becomes the beneficiary for the alimony trust. Generally, a third-party serves as an intermediary between the two spouses to keep the asset management structured in a way that suits both. Once the trust is set up, distributions of all of the income generated in the agreed upon time period go to the recipient spouse.

When alimony comes to an end, or the recipient spouse dies, the trust can be used to fund college for children or grandchildren, donated to a charity or even turned over to the widow or widower.

When it comes to taxes, the only difference for the recipient spouse, under Section 682 of the Internal Revenue Code (IRC), is that he or she will report the income as a beneficiary of a trust instead of alimony. The spouse providing income from the trust is actually better off because he or she is not required to pay income taxes on the income generated by the trust. However, tax deductions for payments are not allowed.