The “Spendthrift” Trust Explained

JULY 27, 2015 VOLUME 22 NUMBER 27

Lawyers love to name and categorize everything they deal with. It’s a useful way to group similar concepts, but it can lead to confusion and misunderstanding. That’s particularly true when a legal concept is non-exclusive — in other words, when one instrument can go by a number of different names. Let’s see if we can address one good example: the “spendthrift” trust.

You might reasonably ask: “is my trust a spendthrift trust?” It likely does not have the term in its name (no one wants to be a beneficiary of the “John Jones Spendthrift Trust” — not even John Jones). How will you know? Because it will have a paragraph somewhere in the trust that says 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.”

It might not read exactly like that (the sample is taken from one of our documents at Fleming & Curti, PLC, and lawyers tend to love tinkering with language like this). It might be identified as “Spendthrift Provision” — or it might not. In Arizona, just calling the trust a “spendthrift trust” is probably sufficient (though we’d never recommend relying solely on the designation).

The point is that the trust’s beneficiary can not sell or transfer their right to receive future distributions from the trust. If there is a provision with similar language, the trust might reasonably be called a “spendthrift” trust. That, in turn, raises other questions:

Does the beneficiary have to be a spendthrift for such a provision to be useful? No. Plenty of very reasonable people, conservative in their financial arrangements and thoughtful about expenditures, get in financial trouble. Or they might be involved in a lawsuit. Or a messy divorce. The spendthrift provision is helpful to keep the beneficiary’s interest in the trust away from those creditors, current or future.

Can I put a spendthrift provision in my own trust? Yes, and we routinely do. But it likely won’t be effective to protect your own assets from your own creditors. The general legal principle is that you can’t shelter your assets from current or future creditors, though there are some exceptions to that rule. This is also one topic on which state laws vary considerably. Ask your lawyer if you are eager to seek protection for your own assets.

Does the spendthrift provision require that someone else be trustee? Wouldn’t it be great if you could set up a trust for your daughter, make her the trustee, and include a spendthrift provision to protect against her creditors? That way she could have complete control of the funds, make decisions about when to distribute money to herself, and still keep her inheritance secure. Turns out you can do just that — at least in most circumstances and in most states.

To keep the protection from slipping away, most of the time lawyers suggest that someone else be trustee of your daughter’s inheritance. It’s not uncommon, though, for your son to be trust of her trust, and for her to be trustee of his trust. That way they can continue to communicate and work with one another, they can help protect one another, and the decisions can stay within the family. Of course, everyone’s situation — assets, family dynamics, family structure — is different, so talk with your estate planning attorney.

Is there anyone who can pierce the spendthrift provision? There might be, depending on state law. Arizona law, for instance, creates a possibility that spendthrift trusts might be reachable for child support payments.

One other possible exception: if the trust requires distributions on a regular schedule, a creditor might be able to collect those future mandatory distributions. But the exceptions are usually very narrow — spendthrift trusts are very effective most of the time.

How likely is it that my trust is not a spendthrift trust? Not very likely. The vast majority of trusts in the U.S. include spendthrift language — or at least the vast majority of lawyer-drafted trusts do.

Should there be a spendthrift provision in my will? It’s a different question for wills, since they usually direct the distribution of all assets outright to beneficiaries in a relatively short period of time. But if your will includes a trust for one or more beneficiaries, you might want spendthrift language in those “testamentary” trusts. Talk with your lawyer about this issue.

We hope this helps. The language can be a little daunting, but lawyers’ categorizations (and labels) are actually understandable and helpful — even by real people.