People create trusts for a lot of different reasons. The most common type is a "living trust." But another common trust, called a "spendthrift trust," is designed to protect "beneficiaries" from themselves and people who would take advantage of them.
Perhaps your loved one has many debts and creditors, is struggling with substance abuse or has a history of out-of-control spending. Or perhaps your loved one has a disability that prevents them from managing finances well. Whatever the reason, a spendthrift trust might offer a solution.
In this article, we'll go over what spendthrift trusts are, how they work, and the important role of the trustee. Learn how you can use spendthrift provisions to protect your loved ones.
A spendthrift trust is any trust that contains language specifically aimed at preventing beneficiaries from squandering their inheritance. People who want to leave substantial amounts of money to their adult children or grandchildren—but don't trust them to manage it wisely—often use spendthrift trusts.
You can use spendthrift provisions to protect all types of assets, including cash, stocks, real estate, and more. Many trusts also generate substantial income; with these trusts, spendthrift provisions can also offer protection. For instance, if you include rental property, dividend-earning stocks, or an annuity in a spendthrift trust for your adult child, the income that asset produces would also be protected.
Spendthrift trusts have two important aspects:
In other words, a spendthrift trust keeps the beneficiaries from spending or borrowing against the trust funds and assets. That means they can't cash in or sell the assets, and they can't use the trust assets as collateral for a loan.
Additionally, spendthrift language is intended to prevent creditors from going after trust funds to pay what a beneficiary owes them. To be effective, the trust must contain very specific language. Here's a typical spendthrift provision you might find in a document creating such a trust:
Except as otherwise provided in this trust agreement, all principal or income that is payable, or will become payable, to the beneficiary of any trust created by this agreement shall not be subject to anticipation, assignment, pledge, sale, or transfer in any manner. No beneficiary shall have the power to anticipate or encumber any such interest. No such interest, while in the possession of the trustee, shall be liable for, or subject to, the debts, contracts, obligations, liabilities, or torts of any beneficiary. Such interests shall also be free from any claim, control, or interference of the spouse of a married beneficiary, or the parent of a beneficiary.
Spendthrift provisions in a trust are often accompanied by other trust provisions that spell out how to distribute assets to beneficiaries—for example, in monthly payments rather than in one lump sum. But it's important to note this distinction: Once your beneficiary actually receives money from the trust, that money is theirs to do with as they please.
Example: Adrian creates a spendthrift trust for his son Carl, who has a gambling addiction. The trust states that Carl will receive a monthly income of $1,000 to be paid from the trust funds. While Carl can't take a loan against the trust assets after Adrian dies, Carl can gamble away the $1,000 he receives every month.
If Adrian was worried that Carl would gamble away his monthly benefit, note that instead of making payments to Carl directly, Adrian could have designed the trust to make payments on Carl's behalf to third parties, like a landlord, to pay for Carl's rent.
And in case you were wondering, you can't stiff creditors by setting up a spendthrift trust for yourself. It only works when you name someone else as the beneficiary.
It isn't possible to lock up trust assets entirely. Under most states' laws, assets held in trust must be used to pay certain kinds of obligations, including child support, spousal support (alimony), and debts incurred for necessities of life, such as food or shelter. Government claims might also be enforceable against trust assets.
For example, a Delaware woman who separated from her husband was owed spousal support. Her husband was the beneficiary of a spendthrift trust that paid him $18,000 every year. She went to court, asking to be paid using the trust's funds. Since she wasn't a "creditor" as defined by state law, the court ruled in her favor and seized the husband's income from the trust to pay her spousal support. (Garretson v. Garretson, 306 A.2d 737, Del. 1973.)
State law might also limit the amount of money that can be protected from creditors. For example, in Oklahoma, creditors can take any income from trust property that exceeds $25,000 per year. (Okla. Stat. Ann. § 175.25.) The first $25,000 is still protected. Notably, only a very large trust would generate more than $25,000 of income in a year.
The "trustee" is in charge of the trust funds and doles them out according to the terms of the trust. The trustee could be a close friend or family member or a hired professional trustee. Since this person will have total control over all of the trust assets for the life of the trust, it's important to use care in choosing a trustee.
With a spendthrift trust, the trustee's job is to safeguard the trust assets and any benefits the beneficiaries will receive. The trustee will also distribute assets to your beneficiaries as the trust document directs. That could mean making payments directly to the beneficiary if the trust allows or requires it. A trust document might also direct the trustee to release all or part of the trust funds to a beneficiary at a specific date or event—for example, when the beneficiary turns 25 or graduates from college.
A trust that's designed to keep money out of the hands of a beneficiary who can't manage finances can also provide for payments to be made to others—schools, landlords, and so on—on the beneficiary's behalf. If the trustee does give trust money directly to beneficiaries, they're free to spend it however they wish.
A special subset of spendthrift trusts is the special needs trust, which works similarly to a standard spendthrift trust. It keeps money out of the beneficiary's hands while still supporting the beneficiary. However, a special needs trust has the additional feature of aiming to protect a disabled person's eligibility for government benefits.
Most people can handle simple estate planning themselves. But when your situation is more complex, there's a lot of money involved, or you have concerns about a loved one's ability to manage money, you might not want to go it alone.
A spendthrift trust must be tailored to fit your situation. The language used must be specific enough to satisfy state laws while ensuring your beneficiaries are protected. Hiring a knowledgeable attorney can help you take care of your loved ones after you're gone.