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How does a spendthrift trust work?
In this article, you’ll learn about:
Let’s dig in.
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A spendthrift trust is a trust designed to protect the trust’s assets from being claimed by the beneficiary’s creditors.
A settlor, the person who establishes the trust, places assets into the trust for the benefit of a chosen beneficiary.
The trust is managed by a trustee who has the discretion to distribute the assets according to the terms set by the settlor.
In a spendthrift trust, the beneficiary cannot sell, pledge, or give away their interest in the trust.
And their creditors cannot access those funds in the trust.
This is because the trust includes a “spendthrift provision”, a clause that restricts a beneficiary’s access to the trust principal.
This provision also bars the beneficiary’s creditors from accessing the trust’s assets until after payments are made to the beneficiary.
However, it’s important to note that there are exceptions.
Certain types of creditors, such as those with claims for child support or alimony, may be able to reach the trust’s assets despite the spendthrift provision.
To set up a spendthrift trust, the spendthrift provision must be expressly declared in the trust instrument.
State laws provide the statutory basis for this type of trust.
From a tax perspective, spendthrift trusts have certain implications for both the trustee and the beneficiary.
And they also play a crucial role in estate planning.
Overall, a spendthrift trust is a valuable tool for asset protection.
But it requires careful consideration and planning to ensure it fits within a broader estate planning strategy.
A spendthrift clause is a provision in a trust agreement that restricts a beneficiary’s access to the trust principal.
This clause also protects the trust assets from the beneficiary’s creditors.
Essentially, it prevents beneficiaries from selling, pledging, or giving away their interest in the trust.
The trustee controls when and how much the beneficiary receives from the trust.
The purpose of a spendthrift clause is to protect the beneficiary from:
This helps ensure the trust’s funds are used as the original creator of the trust intended.
A spendthrift trust is a type of trust designed to protect the trust’s assets from being claimed by the beneficiaries creditors.
Let’s say Mr. Johnson is setting up a trust for his son, Brian.
Brian has had a history of poor financial decisions and debt.
Mr. Johnson doesn’t want Brian’s creditors to seize the money he intends for his son’s well-being.
So he sets up a spendthrift trust.
In the trust document, he includes a clear spendthrift clause.
This prevents Brian’s creditors from reaching the assets within the trust.
The trust assets are managed by a trustee, who Mr. Johnson has appointed.
This trustee has the discretion to make distributions to Brian for his needs, such as food, shelter, and education.
However, the assets within the trust cannot be used to pay off Brian’s creditors.
If Brian incurs more debt, his creditors cannot force the trustee to pay from the trust assets.
The spendthrift trust ensures that the money Mr. Johnson set aside is used for Brian’s care and well-being, not to pay off his debts.
In most states, spendthrift trusts are allowed by law.
The laws state that a spendthrift provision in a trust is valid.
A spendthrift provision restricts the beneficiary’s ability to transfer their interest in the trust.
Trust law is largely based on the Uniform Trust Code (UTC).
The UTC is a comprehensive model law.
It provides clear, consistent rules for establishing and managing trusts.
However, some states have made specific adjustments to the UTC.
These modifications aim to address local needs and customs.
Here are a few examples:
These adjustments ensure that the state trust laws fit its legal environment.
They reflect the state’s balance between:
Under most state laws, you can set up a spendthrift trust.
This type of trust is a legal tool that provides a shield for a beneficiary’s assets from their creditors.
A critical requirement is that you must expressly declare a spendthrift provision in the trust instrument.
This provision specifies that the trust’s assets are not within the control of the beneficiary until the trustee makes a distribution.
Spendthrift trusts offer substantial protection under some state laws.
They place the trust’s assets out of reach from the beneficiary’s creditors, securing the beneficiary’s future income.
However, this protection differs between voluntary and involuntary transfers.
Involuntary transfers, like judgments from lawsuits or creditor claims, can’t typically reach the trust’s assets.
But a beneficiary cannot voluntarily assign their interest in the trust to another party.
This clear distinction enhances the safeguarding effect of the trust.
It reinforces its role as a robust tool for asset protection.
Let’s look at each person’s role in the spendthrift trust.
A settlor, also known as a grantor or trustor, is the individual who establishes a trust.
Any competent adult can act as a settlor.
The settlor’s main duty is to transfer assets into the trust.
This often involves drafting a trust agreement that details the terms of the trust.
The settlor has significant power to shape these terms, including decisions about:
The trustee is the individual or institution entrusted with managing the trust assets.
Duties of the trustee include:
State laws gives trustees a certain amount of discretion in making distributions.
But this discretion must be exercised within the parameters set out in the trust agreement.
The beneficiary is the person or entity who benefits from the trust.
In a spendthrift trust, the beneficiary has the right to receive distributions as set forth in the trust agreement.
However, the beneficiary cannot freely access or control the trust assets.
The beneficiary cannot pledge, sell, or assign his or her interest in the trust.
These restrictions serve to protect the trust assets from the beneficiary’s creditors.
Let’s look at how effective spendthrift trusts are at:
Creditors have rights to collect debt from individuals and their assets.
In some states, spendthrift trusts limit creditors’ rights to access trust funds.
Despite these protections, there are exceptions.
Creditors can reach the trust assets if they are seeking payment for child support or alimony.
Spendthrift trusts also play a role during bankruptcy proceedings.
They provide protection for trust assets, keeping them outside the bankruptcy estate.
The U.S. Supreme Court case, Patterson v. Shumate, established this principle.
However, this protection is not absolute.
Depending on the bankruptcy case specifics, some or all of the trust assets may still be subject to claims.
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