A spendthrift trust is a type of trust that includes provisions specifically designed to protect a beneficiary’s inheritance from their own creditors and from their own poor financial decisions. It is one of the most practical and widely used trust provisions in estate planning and can be included in almost any type of trust — revocable or irrevocable, living or testamentary.
The name comes from the old-fashioned term spendthrift — a person who spends money wastefully or irresponsibly. A spendthrift trust is designed to protect beneficiaries who may not be capable of managing a large inheritance wisely.
How a spendthrift trust works
A spendthrift trust works by restricting the beneficiary’s ability to access trust assets directly or to transfer their interest in the trust to someone else. The beneficiary cannot voluntarily assign their future trust distributions to a creditor and creditors generally cannot reach the trust assets directly before they are distributed to the beneficiary.
Instead of having direct access to the trust assets the beneficiary receives distributions according to the terms of the trust document as determined by the trustee. Only after assets are distributed to the beneficiary do they become subject to the beneficiary’s creditors.
The trustee has the authority and in some cases the obligation to withhold distributions if they would immediately be seized by creditors. This gives the trustee an important tool to protect the beneficiary’s financial wellbeing.
Why spendthrift trusts are used
Spendthrift trusts are used in a wide variety of situations where a grantor wants to leave assets to a beneficiary but is concerned about how those assets will be managed or protected. Common reasons to include spendthrift provisions include:
- Financial irresponsibility — the beneficiary has a history of poor financial management, excessive spending, or inability to save
- Addiction issues — the beneficiary struggles with alcohol, drug, or gambling addiction that could lead to rapid dissipation of inherited assets
- Creditor problems — the beneficiary has significant existing debts or is at risk of future creditor claims
- Divorce protection — spendthrift provisions can help protect trust assets from being counted as marital property in a divorce proceeding in many states
- Young beneficiaries — young adults who have not yet developed financial maturity may benefit from the structure of a spendthrift trust
- Lawsuit risk — beneficiaries in high-liability professions such as medicine or business may face lawsuit risk that could threaten directly inherited assets
- Special circumstances — any situation where the grantor believes the beneficiary needs protection from themselves or from outside claims
What spendthrift provisions protect against
A properly drafted spendthrift provision generally protects trust assets from:
- Voluntary assignment — the beneficiary cannot pledge or assign their future trust distributions as collateral for a loan
- Creditor attachment — creditors generally cannot attach or garnish the beneficiary’s interest in the trust before distribution
- Bankruptcy claims — trust assets may receive some protection in the beneficiary’s bankruptcy proceedings depending on state law
- Divorce claims — in many states a spouse’s interest in a spendthrift trust may be protected from division in divorce
What spendthrift provisions do not protect against
Spendthrift protections have important limits. In most states a spendthrift trust does not protect against claims from:
- Child support obligations — courts generally allow child support claims to reach spendthrift trust distributions
- Alimony and spousal support — similar to child support, spousal support claims may be able to reach trust distributions in many states
- Government claims — federal and state government claims including tax liens may be able to reach trust distributions
- Creditors who provided necessities — in some states creditors who provided food, shelter, or medical care to the beneficiary may be able to reach distributions
Once distributions are made to the beneficiary the spendthrift protections end — the distributed assets are then fully subject to the beneficiary’s creditors. This is why trustees of spendthrift trusts sometimes choose to pay providers directly rather than distributing cash to the beneficiary.
Trustee discretion in spendthrift trusts
Many spendthrift trusts give the trustee discretion over when and how much to distribute to beneficiaries. This discretionary authority is an important tool for protecting beneficiaries. A trustee who knows that a beneficiary is facing a creditor claim or struggling with addiction can withhold distributions temporarily to prevent the assets from being lost.
The trust document should clearly describe the trustee’s distribution powers — whether they are mandatory, discretionary, or a combination — and provide guidance on the factors the trustee should consider when making distribution decisions.
Self-settled spendthrift trusts
Traditional spendthrift trusts are created by one person — the grantor — for the benefit of another — the beneficiary. In a traditional spendthrift trust the grantor cannot also be the beneficiary.
However some states have enacted laws allowing self-settled spendthrift trusts — also called domestic asset protection trusts — in which the grantor can be both the creator and a beneficiary of the trust while still receiving some creditor protection. States that allow domestic asset protection trusts include Nevada, Delaware, South Dakota, and Alaska among others. These trusts are complex and their effectiveness varies significantly by state.
Including spendthrift provisions in a trust
Adding a spendthrift provision to a trust is relatively straightforward — it is a specific clause included in the trust document that restricts the beneficiary’s ability to transfer their interest and restricts creditors from reaching trust assets before distribution.
An estate planning attorney can draft appropriate spendthrift language that complies with your state’s laws and provides the maximum protection available. The specific language used and the scope of protection provided can vary significantly so working with an experienced attorney is important.
Key terms to know
- Spendthrift trust — a trust with provisions that protect a beneficiary’s inheritance from creditors and from the beneficiary’s own financial decisions
- Spendthrift provision — the specific clause in a trust document that restricts the beneficiary’s ability to assign their interest and restricts creditor access
- Trustee discretion — the trustee’s authority to decide when and how much to distribute to beneficiaries
- Self-settled trust — a trust in which the grantor is also a beneficiary
- Domestic asset protection trust — a self-settled trust allowed in certain states that provides creditor protection for the grantor-beneficiary
- Voluntary assignment — the transfer of a beneficiary’s interest in a trust to another party such as a creditor
- Attachment — a legal process by which a creditor seizes a debtor’s property or interest in property
Sources
- American Bar Association — Public Resources
- Uniform Law Commission — uniformlaws.org
- USA.gov — Estate Planning
This article is for general informational purposes only and does not constitute legal advice. Spendthrift trust laws vary significantly by state. Consult a licensed attorney for guidance specific to your situation.