Spendthrift trusts, as the name implies, are designed to protect beneficiaries who spend every penny they get their hands on, and then some. Known as support trusts in some states, these can also be helpful in providing for someone, usually an adult, who can't manage his or her own finances.
You might expect to control spendthrifts with a strong trustee, who distributes trust funds carefully. However, that may not fully protect a trust beneficiary with a desperate need for funds. There are individuals and organizations who buy out trust beneficiaries, paying them perhaps 20% on the dollar. That is, for a chunk of cash now, a beneficiary might transfer his interest to future income and the distribution of trust principal.
A spendthrift trust forbids the beneficiary from selling or assigning his interest in the trust and places it beyond the reach of creditors. In a typical spendthrift trust, the trustee is instructed not to give large sums outright to the beneficiary, but to use his own discretion. A trustee, for example, could pay the beneficiary's housing costs, utilities, insurance premiums and so on, and perhaps provide a spending allowance as well.
Sometimes a spendthrift trust is not meant to last until termination. A variation is sometimes known as an incentive trust. This might specify that if the beneficiary shows signs of being able to handle money--in the trustee's judgment perhaps as a result of earning a substantial income--the beneficiary can receive more funds from the trust.
Observation: A spendthrift trust also can keep assets from a child's spouse, in case of a divorce.
Spendthrift trusts are not necessarily restricted to children. You may be concerned about your spouse's ability to manage money after your death. It may be hard for her to turn down requests from relatives regarding "business opportunities," unexpected expenses and so on. A spendthrift trust can protect her, preserving lifetime income.
There are, as you might suspect, some limits on spendthrift trusts:
* You can't shift your own assets into a spendthrift trust to protect yourself from creditors.
* In most cases, court orders for child support can't be avoided by means of a spendthrift trust.
With a spendthrift or a support trust, the trustee is expected to provide "necessary" sums for the beneficiaries to live on. This raises the question, "What is necessary?" Help the trustee by spelling out your intentions as specifically as possible in the trust documents.
Modern Spendthrift Trust
Modern Trusts were developed at common law in England originally to minimize the impact of inheritance taxes arising from transfers at death. The essence of the trust was to separate "legal" title, which was given to someone to hold as "trustee", from "equitable title", which was to be retained by the trust beneficiaries.
In the United States and England, a practice developed whereby trust settlors began to use "spendthrift" clauses to prevent trust beneficiaries from alienating their beneficial interests to creditors. Over time, courts were asked to determine the efficacy of spendthrift clauses as against the trust beneficiaries seeking to engage in such assignments, and the creditors of those beneficiaries seeking to reach trust assets. A case law doctrine developed whereby courts may generally recognize the efficacy of spendthrift clauses as against trust beneficiaries and their creditors, but not against creditors of a settlor.
To protect creators of trusts, it is usually required to create the protection prior to declared judgments, liens, and other obligations.
Traditional Spendthrift Trust
A spendthrift trust is a trust that is created for the benefit of a person (often is unable to control spending) that gives an independent trustee full authority to make decisions as to how the trust funds may be spent for the benefit of the beneficiary. Creditors of the beneficiary generally cannot reach the funds in the trust, and the funds are not actually under the control of the beneficiary.
Spendthrift Trust Definitions
The creator of a trust (whether or not it is a spendthrift trust) is sometimes called the "trustor", "creator", "grantor" or "settlor" of the trust. A trust often will not be treated as a spendthrift trust unless the trust agreement contains language showing that the creator intended the trust to qualify as spendthrift. This is what is known as a spendthrift clause or spendthrift provision.
A spendthrift provision in an irrevocable trust prevents creditors from attaching the interest of the beneficiary in the trust before that interest (cash or property) is actually distributed to him or her. Most well drafted irrevocable trusts contain spendthrift provisions even though the beneficiaries are not known to be spendthrifts. This is because such a provision protects the trust and the beneficiary in the event a beneficiary is sued and a judgment creditor attempts to attach the beneficiary's interest in the trust.
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Create separate trusts for separate assets or individual investments.