What is a “spendthrift trust”? It’s a question I hear frequently from my clients. I find that more and more clients are interested in having trusts as part of their estate plans. Today, I want to explain some of the basic concepts surrounding trusts and, in particular, the concept of a spendthrift trust.
What is a trust? A trust is a fiduciary relationship through which one individual or entity, called the “trustee,” holds property for another individual, called the “beneficiary.” A trustee could be a person or an institution, such as a bank. A fiduciary relationship exists when the trustee, a fiduciary, holds the property of another person, the beneficiary of the trust, with an obligation of utmost care. In other words, a trustee has a strict duty to conservatively invest and distribute the assets of the trust for the benefit of the beneficiary, the beneficial owner of the property.
The “grantor” of a trust is the person who creates the trust and places assets in the trust for the trustee to manage and invest for the benefit of the beneficiary. A trust could be in the last will and testament of the grantor. This type of trust is called a testamentary trust. A testamentary trust is ineffective until the grantor dies because a Will is ineffective until the grantor dies.
A trust could also be created during the grantor’s lifetime. This is called a “living trust” because it is created during the lifetime of the grantor, as opposed to a testamentary trust, which is created in the Will of the grantor.
There are various reasons why a grantor might create a trust. The child of the grantor might be disabled or having issues with drugs or alcohol. The child of the grantor might have problems managing money. The grantor might wish to ensure that his money is used for the benefit of his family members and never passes to an in-law. Trusts could be used to accomplish all of these purposes.
A trust can contain a “spendthrift trust” provision. One of the primary benefits of a trust is that while the trustee is holding the assets in the trust for the benefit of the beneficiary, the assets are protected from the beneficiary’s creditors if the trust contains a spendthrift trust provision.
Many of my clients see a clause in their Will that says “Spendthrift Trust,” and they believe, understandably, that there is trust in their Will called a spendthrift trust. The fact of the matter is a spendthrift trust is a provision of a trust. It is a provision that protects the assets of the trust from the beneficiary’s creditors; it is not, in and of itself, a trust. It is merely a clause in a trust.
This clause can be very helpful. Let’s assume that Mr. Smith establishes a trust in his Will for the benefit of his son, Joe. Joe has problems managing money and owes many debts. Mr. Smith appoints his daughter Mary to be the trustee of Joe’s trust. The trust contains a spendthrift trust clause.
Mary will invest and manage the money of the trust. Joe is the beneficial owner of the property in the trust. Mary, as trustee, holds legal, but not beneficial, title to the property in the trust. For this reason, and because of the spendthrift trust clause, Joe’s creditors, the people to whom he owes money, cannot get access to the property.
Mary could purchase items for Joe. For instance, Mary could pay Joe’s rent, pay for his groceries. In this way, Mary is never, or rarely, distributing money to Joe, so Joe’s creditors cannot reach the money in the trust.
For this reason a trust with a spendthrift trust clause can be very helpful in certain situations. Even for people who do not have issues managing money, life can have strange ways of changing a person’s circumstances. Interestingly, Joe could be the trustee of his own trust and the trust could still contain a spendthrift trust and protect the assets from Joe’s creditors.
A spendthrift provision can be useful when there are concerns about how assets will be managed over time. Structuring it properly helps ensure that funds are preserved and used in a way that reflects the original intent.