What Is a Spendthrift Trust?
A spendthrift trust is a trust that prevents a beneficiary from immediately depleting the assets and properties that the trust contains by having a trustee release the assets in a controlled and incremental manner. A spendthrift trust also protects the beneficiary from creditors, since the assets are owned by the trust rather than the individual.
How Does a Spendthrift Trust Work?
A spendthrift trust provides incremental income to a beneficiary similar to the way annuities provide guaranteed regular income. They are managed by an independent trustee appointed by the grantor. The trustee disburses funds according to the grantor’s instructions.
A spendthrift trust created during the grantor’s life is known as a living trust. In such cases, the grantor often serves as the trustee, naming a successor to continue after the grantor’s own death.
A spendthrift trust is a prudent way to manage the trust payments made to a beneficiary that lacks fiscal discipline. It lets the trustor take solace in the fact his or her heir will be provided for in a way that minimizes the potential for the inheritance to be squandered or seized by creditors.
How Do You Set Up a Spendthrift Trust?
A spendthrift trust is set up similar to any other trust. The key differentiator is including a spendthrift provision, which is language that outlines the trustee’s responsibilities, such as how and when assets are to be distributed to the beneficiary.
Spendthrift trusts can be created as either revocable, meaning they can be modified by the trustor, or irrevocable, meaning they cannot be changed. An irrevocable trust offers taxation and probate benefits, along with better protection from creditors. However, some grantors prefer the flexibility of a revocable trust.
Creating a spendthrift trust also calls for careful thought and attention to detail, considering the many state-specific laws governing trusts. Be sure to consult with an in-state attorney.
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Can Spendthrift Trusts Be Broken?
Generally speaking, spendthrift trusts cannot be broken. A revocable spendthrift trust can be modified by the grantor during their lifetime through proper legal channels.
Trusts are designed to be unbreakable, though that does not mean they cannot be challenged. A spendthrift trust in particular is designed to protect the trust’s resources against both creditors and any potentially damaging impulses of the beneficiary.
Example of a Spendthrift Trust
For an example, assume you have an estate worth $2 million. With a steady stream of retirement income from Social Security and your pension, your finances are solid enough that you decide to leave the entirety of your $2M estate to your only child, Jack.
Regrettably, Jack is irresponsible with money. He has a history of poor decision-making skills, and you worry that he’ll immediately deplete your hard-earned estate, leaving himself no resources for the future.
In consultation with your estate planning attorney, you decide that rather than transferring the entire estate to Jack at your death, you will instead transfer your assets into an irrevocable trust that includes a spendthrift provision to ensure Jack receives adequate living expenses on a monthly basis.
You appoint a trustee and name Jack as the beneficiary, specifying that he receive $5,000 a month on the first of every month. To keep pace with rising costs, you annually index the payments to match the Consumer Price Index, and grant your trustee the ability to disburse extra payments in the event of an emergency.
Now you know Jack will benefit from your estate for years to come, and you can feel secure in the knowledge that neither potential creditors nor reckless spending will be able to attack the assets of the trust.
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How Does a Spendthrift Trust Differ From a Traditional Trust?
According to an article from the IRS, a trust is a three-party arrangement in which the first party — the grantor — transfers legal title of the trust property to a second party — the trustee — to hold and manage for a third party — the beneficiary — according to the grantor’s intent.
The three parties involved in a spendthrift trust are:
- Grantor: The creator of the trust (also known as the trustor or settlor) who transfers assets into it and sets the instructions for disbursement.
- Trustee: The person or entity to manage the trust’s assets in accordance with the terms of the trust agreement.
- Beneficiary: The person who receives the distributed money or benefits from the trust.
A spendthrift trust also includes a spendthrift provision. And unlike some other types of trusts that close when the grantor dies and the remaining assets are given to the beneficiary, a spendthrift trust stays in place after the grantor’s death. The assets continue to be disbursed to the beneficiary according to the terms of the trust, but the beneficiary cannot directly access the assets of the trust.
What Is a Spendthrift Provision?
A spendthrift provision is what turns a trust into a spendthrift trust. The language of the spendthrift provision details precisely how a beneficiary has access to the trust’s assets. For instance, it outlines the number of payments, how and when the payments will be issued by the trustee, and any circumstances in which the payments might be increased.
Benefits of a Spendthrift Trust
A spendthrift trust can be a helpful choice for grantors concerned about potentially reckless behavior or spending habits by the beneficiary.
Advantages of a Spendthrift Trust
- Releases payments in an incremental manner, rather than in a lump sum
- Protects the assets in the trust from any creditors that your beneficiary may have
- Avoids probate if established while the grantor is alive
Drawbacks of a Spendthrift Trust
Spendthrift trusts are a financial tool, and like many other financial tools, they have both pros and cons.
Disadvantages of a Spendthrift Trusts
- Can be complicated to set up, since rules and provisions differ from state to state
- Might be expensive to maintain given the need to retain a trustee for the life of the trust
- Can be challenged by the beneficiary in court — a lengthy and costly procedure