Suppose you have spent your whole life building your wealth. You wanted to provide for your loved ones long-term, well after you were gone. But what if one of your children is a little irresponsible?
Imagine a situation where one of your children has access to their inheritance and blows the first distribution in no time. They continue their extravagant spending because they know another distribution is coming. Their creditors come calling and make claims on the bulk of their future inheritance. How can you, as a grantor, protect your child from themselves and their creditors?
What is a spendthrift trust?
A spendthrift trust is structured to limit a beneficiary’s access to their inheritance. They are usually established by grantors who have reason to believe that their offspring won’t use the money and property they are gifted with in a responsible way or that they may get into trouble with creditors. They may also be concerned that their child would be easily deceived or defrauded, they have an addiction, or a spouse or relative may take their inheritance after a divorce.
With a spendthrift trust, you can distribute assets to your child more gradually and in a controlled manner. Even if they are careless with their first distribution, the rest of their inheritance is still protected. This can help protect your beneficiary and keep their inheritance from being seized by creditors.
How does a spendthrift trust work?
A grantor or funder for the trust establishes it and funds it with property and accounts. The trust instructions provide specific guidelines on when and how the trustee will distribute the assets to the beneficiary. It also specifies any decisions the beneficiary can or cannot make independently.
A spendthrift trust can be established within the grantor’s lifetime or take effect upon their death. It may also be structured as a revocable or irrevocable trust.
The role of a trustee is especially important when managing a spendthrift trust because they have the authority to control how the beneficiary can use the funds.
Since the beneficiary does not own the assets in a spendthrift trust, they are protected from their creditors. However, once the money is distributed to the beneficiaries, it is no longer protected from creditors.
Who should you choose to be a trustee of a spendthrift trust?
The role of trustee for a spendthrift trust comes with many responsibilities, which can take time. While you can compensate your trustee for their time and effort, it is important to ensure the person you choose makes sense in this situation.
- Will they be able to exercise their discretion when making distributions?
- Should you choose a family member or friend for this role, or would hiring a professional firm, bank, or investment company be better?
- Are there any family dynamics you need to consider that may impact a trustee’s ability to act fairly?
- Will the trustee be given the power to withhold distributions if it is appropriate? Will they be able to follow through on this?
Are there exceptions to the spendthrift trust protections against creditors?
Yes, there are exceptions under which creditors must be paid from a spendthrift trust.
Under section 502 of the Uniform Trust Code (2000):
“A beneficiary may not transfer an interest in a trust in violation of a valid spendthrift provision and, except as otherwise provided in this [article], a creditor or assignee of the beneficiary may not reach the interest or a distribution by the trustee before its receipt by the beneficiary.”
Section 503 explains the exemptions to the spendthrift provisions.
Suppose a benefactor’s child, spouse, or former spouse has a judgment or court order against the beneficiary for support or maintenance. In that case, they may obtain a court order attaching present or future distributions to or for the beneficiary’s benefit.
This also applies to a judgment creditor who provided services to protect a beneficiary’s interest in a trust.
Also, a claim by the state or the United States to the extent of the law of that state or federal law provides is an exemption to the spendthrift provision.
If you are concerned that one of your beneficiaries may have difficulty managing their inheritance and you want to protect them by using a spendthrift trust, schedule a call with us at 855.631.3457 to discuss whether a spendthrift trust is the best estate planning tool to protect your beneficiary.