If you want to leave money or assets to a beneficiary with debt or other creditor concerns, you likely want as much of the funds to go to the beneficiary – not the creditors – as possible. One way to accomplish this goal is with a spendthrift trust.
A spendthrift trust is a trust that contains provisions restraining both voluntary and involuntary transfer of a beneficiary’s interest. In other words, the beneficiary is prohibited from transferring his or her interest in the trust assets to another person, and other people cannot attach a claim to the trust assets or income as a result of money owed to them by the beneficiary.
In this article, we’ll walk you through how spendthrift trusts work, their primary advantages and disadvantages, how to make a spendthrift trust, and considerations to determine whether a spendthrift trust may be right for you.
How does a spendthrift trust work?
Ordinarily, the creditors of a person in debt may attach claims to money or assets that person receives or is due to receive as a gift in someone else’s estate plan just as they could with any other asset (Uniform Trust Code, SS 501).
While in some cases state law limits the percentage that creditors may claim, so-called “spendthrift provisions” in a trust offer more robust protection.
Spendthrift provisions prevent creditors from reaching trust assets in the following ways:
- Prevents the beneficiary from assigning or transferring the beneficiary’s future in the trust
- Prevents creditors from attaching to the assets of the trust before the assets are distributed to the beneficiary
- (Possibly) empowers the Trustee to withhold distributions to the beneficiary at the Trustee’s discretion
Trustmakers can use spendthrift provisions flexibly in their trusts. For example, a Trustmaker may choose to subject the interest of some beneficiaries to spendthrift protection but not others. A Trustmaker may also choose to subject only a portion to the trust to spendthrift protection (i.e., protect the income of the trust assets but not the principal).
What are the advantages of a spendthrift trust?
The primary advantage of a spendthrift trust is that it makes the trust assets virtually untouchable by a beneficiary’s creditors until the assets are distributed to the beneficiary.
Protected by the spendthrift provisions, the trust assets are not considered part of what the beneficiary owns. Creditors therefore can’t make a claim on the trust assets, and with less assets in hand, the beneficiary may be better able to settle the creditor claims for less than the total amount claimed.
What are the disadvantages of spendthrift trust?
Spendthrift provisions do not offer bulletproof protection against creditors. When adding spendthrift provisions to your trust document, keep in mind that spendthrift provisions:
- Do not block all creditor claims, including in some cases, the case of a beneficiary who has unpaid child or spousal support or a claim held by the State or US federal government (i.e., the IRS)
- Do not restrict creditors from attaching to a “mandatory distribution” that the Trustee is required to make to the beneficiary under the express terms of the trust, such as a distribution upon termination of the trust (Uniform Trust Code, SS 506).
- Prevent the beneficiary from pledging their interest in the trust as collateral for a loan. For example, spendthrift provisions would prevent even a debt-free beneficiary from taking out a loan backed by the beneficial interest to purchase a house prior to actually receiving trust distributions
- Do not prevent creditors of the Trustmaker from reaching the trust assets, to the extent such trust assets remain under the control of the Trustmaker, such as in a revocable living trust
- Place more discretionary power in the Trustee increasing the opportunity for Trustee abuse of power (if also making distributions subject to discretion of Trustee)
Additionally, it’s worth considering that absent a spendthrift trust, an indebted beneficiary may benefit from using the gifts under an estate plan to settle outstanding debt by avoiding drawn out litigation and settlement processes.
How to make a spendthrift trust
A spendthrift trust is valid only if it restrains both voluntary and involuntary transfer of a beneficiary’s interest in the trust. The below language is suitable for creating a spendthrift trust:
“The trust for [Beneficiary Name] shall be a spendthrift trust to the fullest extent allowed by law. Prior to the actual receipt of trust property by the beneficiary, no property distributable under the trust shall voluntarily or involuntarily be subject to assignment by the beneficiary or to attachment by any creditor or assignee of the beneficiary. Any attempted transfer or encumbrance of any interest in such property by the beneficiary prior to distribution shall be void.”
However, since spendthrift trusts are so common, including a simple provision in your trust agreement that the interest of a beneficiary is held subject to a “spendthrift trust” is generally sufficient to make a trust a spendthrift trust (Uniform Trust Code, SS 502).
Should I make a spendthrift trust?
Spendthrift provisions are very common and often added to trust documents with very little thought – sometimes even without discussion between the attorney and the Trustmaker.
At Just In Case Estates, we always ask our members whether they would like to make their gifts subject to spendthrift provisions. Choosing to add or not add spendthrift provisions is as easy as one click in our step-by-step questionnaire.
As you’ve learned in this article, spendthrift provisions can have important consequences for your beneficiaries, and therefore it’s important to consider the advantages and disadvantages of spendthrift trusts as applied to your personal situation.
If you have more questions on spendthrift trusts, let us know by getting in touch with our Member Success team.
When you’re ready to make your own trust – whether or not you choose to include spendthrift provisions – get started for free with Just In Case Estates revocable living trust plan.
