One of the biggest concerns a trust creator might have is that the beneficiary would squander their inheritance or that the beneficiary’s creditor would attach the inheritance to cover the beneficiary’s debt. To prevent it from happening, a “spendthrift trust” can be created for a beneficiary or a "spendthrift provision" can be included in a trust or a will.
A spendthrift trust is a trust that can be created for the benefit of a financially irresponsible person. It gives an independent trustee the authority to make decisions as to how the trust funds may be spent to assist the beneficiary. While a trusted family member can serve as a trustee for little or no pay, the concern is that such person might not live long enough or might not be capable of serving as trustee as long as required. Additionally, conflicts among the family members are not unusual, especially when money is involved. For those reasons, an independent and long-lasting trust company or a bank might be a better choice as a trustee. Unfortunately, their services are typically expensive and therefore more often recommended for a large estate.
Additionally, a spendthrift trust allows for the funds to be protected against present or future creditors of the beneficiary. For example, if a parent wants to leave money to his or her child, but wants to make sure that the child’s present or future creditors cannot access it, a spendthrift trust is allowed because a parent does not typically have a duty to pay an adult child’s debts.
It is more difficult to set up a spendthrift trust to protect one’s own money from legitimate creditors. While it can be done, it should be approached with great caution, and there are very strict rules and limitations. Very importantly, the trust cannot be created with an intent to defraud, delay, or hinder the creditors. Noteworthy, the control over the trust assets must be relinquished to another person. Even then, it is difficult to foresee whether the court will consider that sufficient amount of control has been given up to allow the trust to protect the assets.
A “spendthrift provision” is a clause that protects a beneficiary from a creditor attaching prior debts against the beneficiary's inheritance. In other words, the clause prevents a beneficiary’s creditor from being able to force a trustee or a personal representative to pay the beneficiary’s inheritance to the creditor instead of to the beneficiary. It further prevents the beneficiary from procuring a debt based on the future inheritance.
However, a spendthrift provision protects the assets only as long as they remain in the trust or in the estate. Once the beneficiary receives a distribution from trust or the estate, the creditors can seek the payment of the debts from the assets that now belong to the beneficiary. That is why in certain situations, when the beneficiary is financially irresponsible, retaining the assets in a spendthrift trust offers more protection than a simple spendthrift provision.
Additionally, to be valid, a spendthrift provision must prevent both the voluntary and involuntary transfer of a beneficiary’s interest.
A spendthrift trust and a spendthrift clause are mainly intended to protect a beneficiary’s inheritance from present and future creditors. They are not intended to assist in defrauding others. And, importantly, it is very unlikely, if not impossible, to set up a trust to legally avoid paying IRS or government entities’ debts.
Natalia Vander Laan is an attorney working in Minden