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Spendthrift trusts can protect your loved ones from themselves

by Kelly Gicale | Contributor
March 8, 2022

When you hear the word “spendthrift,” what comes to mind? For many people, they immediately think about someone who cannot be trusted with money, or someone with a spending problem.

One of the main reasons that people decide to embark on personal estate planning is to provide protections for their hard-earned assets. The idea is that you want your chosen beneficiaries, and not third parties, to benefit from your legacy. Fortunately, your estate plan can be structured to provide such protection for your assets and for your loved ones after your lifetime.

A very common tool for estate planning overall, and for asset protection specifically, is a revocable living trust. This is because a revocable living trust can easily be structured to provide asset protection by including a properly drafted spendthrift clause. This kind of clause can prevent creditors and others from being able to take the inheritance you leave for your family members or friends. As a result, a spendthrift clause is included in most revocable trusts, regardless of whether the beneficiary is frugal or frivolous with money.

In this article, you'll find useful information about using a spendthrift trust to protect your assets, including an overview of what a spendthrift trust entails, when it can be especially useful, and the benefits of using a spendthrift trust in your estate plan.

What is a spendthrift trust?

To start, a trust is a legal entity created to hold assets for the benefit of certain persons or entities. A spendthrift trust is a specific kind of trust that includes provisions that limit a beneficiary's access to its principal, under the oversight of a trustee.

With a spendthrift trust, the beneficiary has no interest in the trust's assets until the trustee makes a distribution. Since the beneficiary has no interest in the trust's assets, any of their potential creditors will not be permitted to reach the assets held in trust to satisfy a debt or other obligation. This is the main source of protection that a spendthrift trust can provide your assets.

In addition, a spendthrift trust's assets are also not subject to equitable division in a divorce. This means that if you arrange for your adult child's inheritance to be left in a spendthrift trust, then a future divorce from their spouse will not result in your son or daughter losing half of their inheritance when their assets are divided, regardless of whether they live in a common law or community property state. So, a spendthrift trust can be excellent insurance against a potential divorce leading to your child losing half of their inheritance.

However, once assets in a spendthrift trust are actually distributed to the beneficiary, then their creditors can go after them to satisfy a debt or other judgment, including equitable distribution in a divorce.

As you can see, despite its name, a spendthrift trust is not only useful when you might be concerned that your beneficiary has a spending problem. Rather, it's a protective tool that can be used by the grantor, or the person who sets up the trust, to provide protection for the trust's assets.

In many cases, a beneficiary also acts as the trustee of a spendthrift trust. A non-beneficiary trustee, however, can provide greater oversight and stronger asset protection.

When is a spendthrift trust used?

Because of the protections a spendthrift trust offers and the ease of adding this protective measure to a revocable living trust, they are almost always used when an experienced estate planning attorney recommends a trust as part of your overall personal estate plan.

In general, a spendthrift trust is commonly used when parents want to pass assets to their family members (children and grandchildren) without subjecting those assets to the beneficiaries' creditors or divorce. This is true whether or not the parents know of a specific risk, like a rocky marriage or known potential legal concerns.

Because no one is immune from lawsuits, divorce, accidents and other uncertain and uncontrollable circumstances, spendthrift provisions are almost always included in every revocable living trust as a safety mechanism against future life events.

What are the benefits of a spendthrift trust?

Spendthrift trusts have three major benefits: 1) protection from a beneficiary's life events, 2) protection from the beneficiaries themselves, and 3) general assistance with finances for an inexperienced beneficiary.

1) Protection from beneficiary's life events

As mentioned above, the most significant benefit of a spendthrift trust is the protection it provides your assets from threats that may come in the form of future lawsuits, divorce, car accidents and high-risk occupations.

Future lawsuits

While most people, in general, do not expect to be subjected to a lawsuit, we live in an extremely litigious society and country where no one is safe from potential legal action. Unfortunately, there are many things that most of us engage in day-to-day that could open us up to legal liability. Home ownership in and of itself can lead to lawsuits, from not taking care of a hazard on your property that harms someone else to inviting someone into your home and having them experience an injury, you never know when you might become a defendant in a lawsuit. Many claims of negligence arise from the most mundane-seeming experiences or events, and you may not even need to act intentionally for another person to succeed in suing you.

a woman going on a shopping spree

As a result, it can be helpful for anyone, regardless of their occupation or daily risk factors, to have the protections provided by a spendthrift trust against a possible future lawsuit.

Divorce

As more than half of marriages end in divorce, this is also a potential life event that could place your assets in jeopardy. Your children may not even be married today, but as your wealth will be transferred to your beneficiaries after your lifetime, there is a great chance that they will be married at some point. And this means that there is also a risk they could be involved in a divorce at some point in the future as well.

While some states consider inherited property separate and therefore not subject to division in a divorce, not all states take that approach. If your child or children ends up living in a state where their inheritance is fair game for their ex-spouse to go after in a divorce, then a spendthrift trust can be invaluable for protecting your assets against that eventuality.

Car accidents

One of the riskiest activities that most people participate in every day is driving. In the United States, there are tens of thousands of car accidents each day. And while not all accidents result in injury or death, many car crashes do involve some kind of harm to one or both drivers.

This means that driving is one of the greatest ways that many of us expose ourselves to potential liability. With your children and grandchildren, this risk will likely only continue to rise with the widespread use of smartphones while driving. As a result, protecting them against the possibility of being sued for involvement in a car accident is going to be important for having peace of mind that the inheritance you leave for them will not be taken by someone seeking damages from should they experience an auto accident.

High-risk occupations

Finally, spendthrift trusts are especially useful when your child or grandchildren work in a high-risk occupation. This could mean working in an industry with greater risk of physical injury, like construction or even owning a business where customers are present in their space, or it could mean working in a profession where there is known risk of litigation for other kinds of harm.

For instance, if your child or grandchild wants to become a doctor, then they may have a greater risk of lawsuits for physical harm or other malpractice claims. Or, while you may not consider a personal finance professional to be a “high-risk” occupation, any kind of career where your loved one is serving as a fiduciary may open them to risk of liability for financial harm.

Your children or grandchildren may not even have begun their professional careers, or they may change careers in the future, so it will be useful to have a spendthrift trust in place just in case they do end up in a role where they could be at greater risk for potential lawsuits.

2) Protection from the beneficiaries themselves

While a spendthrift trust is not only needed when a beneficiary has a spending issue, it can be useful to use to protect your loved ones from themselves when you already know of potential concerns in managing funds. This is because you can name someone else to serve as trustee – someone who is adept at managing money – so that they have discretion for distributing funds. In that way, you can protect your loved one from their propensity to mismanage funds or overspend unwisely. Here are a few scenarios that could apply to your beneficiaries:

Poor money management skills (being an actual spendthrift)

If you have a child or grandchild that you know has trouble with overspending, then you absolutely will want to consider a spendthrift trust to protect them from themselves.

In addition to protection from creditors, a spendthrift trust protects your assets from immediate spend down by placing the power to make distributions in the hands of a reliable trustee of your choosing. In this situation, it obviously would not be smart to name the beneficiary as the trustee. Instead, you could name a trustee that you know is financially savvy so that they can determine if and when to release assets from the trust for your beneficiary to use.

Similarly, the terms of the trust can be crafted to limit the use of the funds for certain specific purposes, which will be discussed below.

Poor judgment

Even if your family member does not have a spending problem, they may not be well-suited to manage a large sum of money received through an inheritance. Whether they are not experienced in personal finance, not yet in a stable position in life, or simply not yet mature enough to handle this kind of responsibility, your children or grandchildren may be better off with a spendthrift trust to ensure that their inheritance is not squandered.

In this situation, it would also be important to name a third-party trustee, or to name a beneficiary who does not have these kinds of concerns as trustee, as it will allow you to provide discretion for distributions to someone who can be trusted with those and other important decisions regarding your assets.

Vulnerability to predators

Finally, we all know people who tend to be easily influenced or taken advantage of because of their kindness and generosity. If you have a loved one who falls into this category, then a spendthrift trust would be useful for protecting them from predators who might try to take advantage of them.

A spendthrift trust won't prevent your child or grandchild from giving away funds to a predator after they've been distributed to him or her, but it could protect them from having someone swindle them out of their inheritance all at once.

3) Providing general assistance with finances for an inexperienced beneficiary

A final benefit of a spendthrift trust is that it allows you as the parent to provide financial support for your children, while also protecting the funds from third parties, unwise choices, and inappropriate spending.

As the grantor of a spendthrift trust, you can control what purposes are permitted for your child or grandchildren to request trust funds. As a result, you can arrange the trust and its terms to provide your loved ones with limits that help them to learn about responsible personal finance.

However, there are limitations on this benefit. A spendthrift clause will not prevent a beneficiary's interest in the trust from being transferred for:

  1. A child support order.
  2. Spousal support or alimony.
  3. Federal and state taxes.

What are the requirements of a spendthrift trust?

Spendthrift trusts must be carefully drafted to protect the trust's assets from creditors. If such asset protection is one of your planning goals, you should speak with one of Legacy Plan's experienced Network Attorneys. If you were to attempt to create a spendthrift trust on your own, you would risk having the trust fail to provide your desired asset protection because of incorrect or general wording.

To successfully create a spendthrift trust, the trust agreement must include the following three specific characteristics:

Provides for the support and maintenance of its beneficiaries

For a spendthrift trust to be valid, it must be established to provide for the “support and maintenance” of your beneficiaries.

The terms “support” and “maintenance” generally include mortgage payments, property taxes, health insurance or care, existing life and property insurance payments, usual vacation, family gifts, and charitable giving. Depending on your preferences, it could also include reasonable additional comforts, luxuries and/or special vacations. In general, however, distributions to increase the beneficiary's wealth or allow them to make extraordinary gifts are not considered support or maintenance.

Expresses grantor's clear intent to protect the trust from the beneficiaries' creditors

This depends entirely on correct drafting. In order to satisfy this requirement, an experienced Legacy Plan Network Attorney will use the language recognized by the law and courts to express your unequivocal intent to protect your beneficiaries from creditors. So, it's especially important to work with someone who is an expert in estate planning law when choosing a spendthrift trust to ensure that this requirement is met.

Clearly provides that the beneficiaries' interest in the trust cannot be voluntarily or involuntarily transferred, assigned, pledged or mortgaged

This requirement also relies solely on competent drafting. In order to be recognized and implemented upon your death, a spendthrift provision in a revocable living trust must provide the “magic language” regarding transferability, assignability, etc. An experienced estate planning professional will know the exact language necessary for your spendthrift trust to be valid, so it's critically important to work with someone who knows and understands the law vs. an online template that could be completely invalid.

Conclusion

For most people, asset protection is an important estate planning goal. This makes complete sense, as the vast majority of us would prefer to take steps to protect the assets and wealth we have spent our entire lives building. If you consider yourself part of this group, then a spendthrift trust is likely an estate planning vehicle you will want to consider incorporating into your overall plan.

A spendthrift trust can protect your estate from the life events of your beneficiaries so that they, and not creditors and soon-to-be ex-spouses, benefit from funds intended for their financial support.

People who engage in estate planning tend to be very thoughtful, forward-thinking, and considerate. To ensure that the plans you carefully create come to fruition, a spendthrift trust can be an invaluable, yet simple, tool to protect your assets and your loved ones whenever the time comes.

How do I create an estate plan?

There are numerous options and scenarios to consider when developing an estate plan that protects your legacy and achieves your objectives, and important decisions should be made with the advice of qualified lawyers and financial experts. Membership with Legacy Assurance Plan provides members with valuable resources and guidance to develop comprehensive estate plans that take life's contingencies into consideration and leave a positive impact for generations to come. Legacy Assurance Plan members also receive peace of mind that a team of trusted, experienced professionals will assist them in developing legal, financial and tax strategies that will meet their needs today and for years to come through periodic reviews.

This article is published by Legacy Assurance Plan and is intended for general informational purposes only. Some information may not apply to your situation. It does not, nor is it intended, to constitute legal advice. You should consult with an attorney regarding any specific questions about probate, living probate or other estate planning matters. Legacy Assurance Plan is an estate planning services company and is not a lawyer or law firm and is not engaged in the practice of law. For more information about this and other estate planning matters visit our website at legacyassuranceplan.com.

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