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How a Spendthrift Trust Can Protect Heirs From Themselves

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Written by Troy Werner

Troy Werner has been an indispensable asset to The Werner Law Firm since joining in 2009, providing exceptional legal service to its clients.

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POSTED ON: April 13, 2021

Sometimes, estate planning is about finding ways to ensure that the wealth you leave behind for your loved ones will last if possible. This is especially important for those worried that their estate may be diminished by creditors or even heirs who are not equipped with the means nor knowledge to use their bequeathment wisely […]

Sometimes, estate planning is about finding ways to ensure that the wealth you leave behind for your loved ones will last if possible. This is especially important for those worried that their estate may be diminished by creditors or even heirs who are not equipped with the means nor knowledge to use their bequeathment wisely and make it last. While the dead have no personal stake in the living lives, a person’s love and concern for their kin can live on past the grave.

As far as estate planning tools go, trusts provide the greatest flexibility and control over their assets after death through the careful handling of a fiduciary or close friend. Spendthrift trust provisions protect the principal of trust from a beneficiary’s potential poor choices while allowing them to benefit from the trust’s continued growth and management under a skilled trustee. Spendthrift trusts can also be used to ensure a portion of your wealth will continue to provide benefits for your dependents, despite creditors.

What Is a Spendthrift Trust?

A spendthrift trust is a form of asset protection trust with clauses meant to protect the heirs to an estate from their own financial decision-making. Their respective trust documents define trusts. Still, they functionally exist through the understanding and agreement between three parties:

    1. The trust’s founder/grantor.
    2. The trust’s recipient beneficiaries.
    3. The managing trustees.

It is up to the grantor to provide the trust’s principal by funding their assets and properties into the trust itself, which becomes a legal entity defined under the trust document's parameters. Upon the grantor’s death, a trustee continues managing the trust in their stead, making distributions to the beneficiary based on the trust’s income, and managing or distributing the trust’s principal as per the grantor’s intents and wishes.

Asset protection trusts are irrevocable trusts designed to limit a grantor’s involvement in the principal’s management and investment, even while the grantor is alive. Through an asset protection trust, the trust’s grantor effectively puts the reins in the hands of the trust’s appointed (and independent) trustee, with instructions on when and how to distribute the trust’s earnings and principal to its respective beneficiaries.

Because these trusts are designed to explicitly separate assets and property from the trust’s grantor (thereby protecting the assets from creditors and even tax liabilities), they are heavily regulated and must be carefully constructed. When a spendthrift clause is added to an asset protection trust, it is often worded so that the beneficiary does not have the right to decide how or when distributions are made and is not allowed to sell or spend the trust’s principal without meeting the trust’s requirements.

Speaking more broadly, asset protection trusts themselves are usually either domestic or foreign, with the former being easier to set up and maintain while providing fewer protections. At the same time, the latter is more expensive but can provide unique advantages. Either way, setting up a spendthrift trust – or any specialized or complex trust – requires a lot of expertise and careful consideration. Only discuss the idea with an estate planning professional and trusted attorney.

How Are Trusts Created?

While the specifics and careful legal language behind an asset protection trust with a spendthrift clause are complex, it largely shares the same setup behind a normal, easy living trust. Aside from the three involved parties, you need someone to write up an individualized trust document built the way you need it, and you need to fund your assets into the trust. Funding a trust involves revising and amending associated ownership documents to reflect each asset or property’s new status under the trust agreement.

For example, if you plan to add your rental properties and the contents of a specific account for investment purposes into an asset protection trust, then you need to deed the properties to the trust’s name and work with the bank to transfer the account into the trust (by making the trust itself the new account holder). Personal property is generally exempt from this – you can fund your baseball card collection into your trust by adding a note to the trust agreement.

Why Irrevocable Trusts?

Irrevocable trusts are much harder to amend than revocable trusts – as the name implies. Because asset protection trusts are built to separate assets from a grantor’s control rendering them more difficult to creditor claims or certain tax liabilities, a larger rift must be created between the grantor and their assets to justify granting these tax-shelter benefits and protections from creditors.

Irrevocable trusts can be amended under specific circumstances, but these are very rare. It is better, too, as a rule, to assume that your irrevocable trust will separate certain assets from you with a distinct finality.

Why Create a Spendthrift Trust?

The primary motivator behind a spendthrift trust is asset protection. This is not always an indictment of a beneficiary’s financial ability. Some heirs may be potentially too young to manage a larger distribution, or you might want to ensure that they receive an appreciable income from the trust while keeping it safe from potential creditors and in the hands of a skilled investment professional.

A professional and independent trustee may be able to grow the trust more efficiently than your beneficiary would, leaving them to focus on what is most important to them while allowing them to reap the benefits of a well-managed trust.

State Considerations for Spendthrift Trusts

It is important to note that individual differences in the state rules and regulations surrounding asset protection and spendthrift trusts, especially about what state or local debts and liens can and cannot be avoided. This is part of the reason why getting help from a professional in estate planning is crucial.

Articles and guides may help you better understand your options for preparing your finances and making important end-of-life care decisions. Still, they cannot substitute tailored legal advice. If you have more questions, contact an estate planning attorney today.

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