Spendthrift Trust

According to Black’s Law Dictionary, a trust is a legal relationship where title to an asset is transferred to a party that has a legal responsibility, or fiduciary duty, to take care of it for the benefit of a third party. The parties involved are as follows:

Many trusts are closed after their grantor dies, and the remaining assets are automatically given to the beneficiary. This is not the case with a spendthrift trust.

A spendthrift trust stays in place after the grantor’s death and continues to hold transferred assets that are released gradually to the beneficiary. This is the key feature of a spendthrift trust — the way it limits a beneficiary’s access to their assets.

At this stage, you may be wondering in which cases a spendthrift trust would be used. Basically, a spendthrift trust does two things:

These features are important when the trustor has concerns about the spending habits, credit exposure or responsibleness of the beneficiary.

The controlled payout pattern provides peace of mind and lets the trustor know the beneficiary will be taken care of, while reducing the risk of having an inheritance squandered away by the beneficiary or seized by creditors.

Remember, the gifted assets belong to the trust, not the beneficiary. The beneficiary cannot access the assets prior to payment, and neither can creditors.

A spendthrift trust is a distinct legal entity. It is created by a grantor to protect assets set aside for gradual transfer to a named beneficiary.

When the trust is first created, the grantor must appoint a trustee to manage the trust according to the grantor’s instructions. The most important instructions relate to how the trustee is expected to give assets to the beneficiary, along with any decision-making abilities the beneficiary may be granted.

A spendthrift trust can be created during a grantor’s lifetime or at the point of the grantor’s death. If the trust is created during the grantor’s lifetime, it is known as a living trust, and the grantor usually serves as trustee until the grantor’s death. At death, a named successor assumes the role.

The process of setting up a spendthrift trust is similar to establishing any other trust. The key difference is the inclusion of a spendthrift provision, which outlines the trustee’s responsibilities, including expectations around how assets are to be given to the beneficiary.

Another important feature of a spendthrift trust is whether it is structured as revocable or irrevocable. A revocable trust can be modified by the trustor; an irrevocable trust cannot. Although some trustors prefer the flexibility of a revocable trust, irrevocable trusts offer more benefits relating to creditor protection, taxation and probate.

While seemingly straightforward, the creation of a spendthrift trust calls for plenty of thought and attention to detail. This is especially true when considering the many state-specific laws governing trusts. Be sure to consult with an attorney to properly form one.

Let’s close with a simple example. Assume you are in the midst of your golden years, with an estate worth $2 million. You also have a more than adequate stream of retirement income from a pension and Social Security.

Your finances look great, so you decide to leave the $2 million estate to Jack, your only child. Unfortunately, Jack has been reckless over the years and is very irresponsible with money.

Fortunately, you have a thoughtful estate planning attorney, and he’s quick to offer a recommendation.

Your attorney has explained that instead of transferring the entire estate to Jack at your death, a spendthrift provision can ensure adequate living expenses are paid to Jack on a monthly basis.

This payout plan sounds ideal, so you transfer the assets into an irrevocable spendthrift trust. You appoint your attorney as the trustee and name Jack as the beneficiary, specifying that he receive $5,000 a month on the first of every month.

For good measure, you index the payments annually to keep pace with the Consumer Price Index (CPI). You also grant your trustee the ability to make extra payments to Jack in the event of a medical emergency.