One of the main goals of estate planning is to pass on assets from one generation to the next. But, how can you ensure that your financially irresponsible beneficiary won’t squander their inheritance? Or, how can you protect your beneficiary’s inheritance from the claims of their creditors? The answer lies in a spendthrift provision.
What is a spendthrift provision?
A spendthrift provision is language put into a trust that prevents a beneficiary from using a future distribution to secure credit. It also prohibits creditors from collecting payment if they extend credit to a beneficiary based on future distributions.
Trusts with a spendthrift provision are often referred to as spendthrift trusts. But, even if you have a spendthrift trust, it likely won’t be in the trust’s name. Still, your trust is probably a spendthrift trust– most trusts in the U.S. are.
If you are wondering if your trust is a spendthrift trust, just look for the spendthrift provision. A spendthrift provision might look something like this:
“Trustee shall not recognize any transfer, mortgage, pledge, hypothecation, assignment or order of a beneficiary which anticipates the payment of any part of the income or principal. The income and principal of the trust estate shall not be subject to attachment, garnishment, creditor’s bill or execution to satisfy any debt, obligation or tort of any beneficiary, nor shall any part of the trust estate pass to a trustee or receiver in any bankruptcy or insolvency proceeding initiated by or against any beneficiary.”
Note that this is just an example taken from one of our documents. Your trust’s spendthrift provision may not read exactly the same. It may be identified in the trust as “Spendthrift Provision” but it also might not. The key is that the language should prevent the beneficiary from selling or transferring their right to receive distributions.
The benefits of a spendthrift trust
The whole point of a spendthrift trust is to protect trust assets from beneficiary’s creditors. This makes them useful for a financially irresponsible beneficiary. But, they can also be helpful for those who can manage their money appropriately. Spendthrift provisions can be helpful for almost anyone. Even the most thrifty among us can get into financial trouble and those who manage their money well can still have their assets jeopardized in a lawsuit or a messy divorce. The spendthrift provision is helpful for keeping away creditors, current or future, in all of those situations.
Limitations of spendthrift provisions
While spendthrift provisions protect assets from most creditors, there are some exceptions. These exceptions vary from state to state. In Arizona, for example, spendthrift trusts may be able to be reached for child support payments. A creditor might also be able to collect those future mandatory distributions if the trust requires distributions on a regular schedule.
Spendthrift provisions really most useful in a third party trust. You can put spendthrift provision in your own trust, but it likely won’t protect assets from your creditors. The idea behind this is that the law doesn’t want you to shelter your own assets from your own creditors. However, this varies from state to state, so you should ask your attorney.
Do I need a trust for spendthrift provisions?
Maybe you’ve read this post and thought that someone in your life could benefit from a spendthrift provision, but you don’t want to make a trust. Could you put a spendthrift provision in your will? You could, but it looks a little different. Generally in a will, distributions are directed to beneficiaries outright and the assets are distributed in a short period of time. Wills can be used to create testamentary trusts though and testamentary trusts can include spendthrift provisions. If you think this might be a good option for you, talk to your estate planning attorney.