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In recent years, trusts have become increasingly popular as estate planning tools. Many people get the impression that they need a trust, but may not understand exactly how a trust operates or what benefits it offers. The good news is that there are many types of trusts with somewhat different features and rules, and they are designed to meet a variety of different needs for those making an estate plan. If you are planning to leave assets to your loved ones, but are concerned that they might be vulnerable to creditors, financial predators, lawsuits, or their own impulsiveness or poor money management, a spendthrift trust might be right for your needs.
What is a Spendthrift Trust?
Before we begin discussing the specifics of a spendthrift trust, let’s talk about what a trust is and is not. Contrary to stereotypes about “trust fund babies,” trusts are not reserved exclusively for the wealthy (although it’s worth noting that those with significant assets usually choose to use trusts in their estate planning). Anyone can have a trust, which is simply a financial arrangement involving three roles.
The first of these roles is the grantor or trustmaker, the person who creates the trust and funds it with assets (trust principal). The second role is that of trustee, the person or organization that manages the assets in the trust and makes distributions. The third role is that of beneficiary. Beneficiaries are the recipients of distributions from the trust.
For some trusts, during the grantor’s lifetime, the grantor can serve in all three roles. After the grantor’s death, a successor trustee takes over and manages the trust for the benefit of the beneficiaries named by the grantor in the trust document. As a grantor, you may elect to have the trust become irrevocable from the outset, or maintain the right to revoke it during your lifetime but have it become irrevocable upon your death.
What is special about a spendthrift trust is that it uses specific language to restrict beneficiaries’ access to trust principal.
What is special about a spendthrift trust is that it uses specific language to restrict beneficiaries’ access to trust principal. This language prevents beneficiaries from removing the income-producing assets from the the trust, or promising those assets to another person. With a spendthrift trust, the beneficiary does not have the right to access the property held by the trust, only to receive distributions through the trustee, according to the terms of the trust document. Because the beneficiary does not have the right to access trust principal, that principal also cannot be reached by their creditors. Only after a distribution is made to a beneficiary is it theirs, and no longer out of the reach of creditors.
Depending on the terms of the trust, distributions may be made on a regular timetable, or if a beneficiary has reached a certain milestone or met a condition, such as maintaining an acceptable grade point average in college. A trust can also be set up so that payments, say, for rent or tuition, are made by the trust for the beneficiary’s benefit, rather than making a distribution directly to a beneficiary.
Who Benefits From a Spendthrift Trust?
Because the law requires spendthrift clauses in a trust to be worded very specifically, it is best to work with an attorney who is experienced in the preparation of spendthrift trusts. An improperly-drafted trust may not offer any of the protections you intend.
If the trust is properly worded, it can:
- Prevent a young beneficiary who is a legal adult, but who lacks the maturity to manage significant assets, from squandering their inheritance
- Protect a trusting beneficiary from being swindled out of assets by con artists
- Prevent a beneficiary’s spouse from asserting that trust assets are marital property, and claiming them in a divorce
- Protect a beneficiary with debt from having creditors seize trust assets
- Protect a beneficiary who may be sued from having a judgment creditor claim trust assets
In addition to protecting assets for beneficiaries, spendthrift trusts, like other trusts, can avoid the expense and hassle of probate and, depending on how a trust is drafted, provide tax benefits. Be aware that many states will not allow a trust’s grantor to name him- or herself as a beneficiary of a spendthrift trust in order to avoid creditors’ claims. If you have claims pending against you, or even if have reason to believe that someone might have a claim against you, even if none have yet been filed, a spendthrift trust will not hold your assets out of reach.
Given the many benefits a spendthrift trust does offer, however, and the fact that there is little to no downside to implementing one, it is worth discussing this option with your estate planning attorney.
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