Spendthrift Trust

Do I need a spendthrift trust? I am the proud father of three children – two very responsible, one a total mess. I want to set up trust funds for each of them for $500,000 each. However, in establishing trust funds for my children, I am reluctant to turn the prodigal son loose. He is unable to manage his financial affairs and spends money with no concern for the future. I do want to provide for his basic needs, but know if he has access to the full $500,000 he will spent it on women, wine, and whatever. Worse, his creditors will probably attach the trust (as has happened in the past when he pledged the asset as collateral for a loan). How can I manage to provide for his support and protect the funds so he doesn’t wind up living in a teepee eating cat food?

Congratulations on raising two responsible children. You have obviously worked hard to build a future for them and it is admirable that you want to pass some of it on. It’s great to have well-grounded, established people in your life who are responsible in every way. However, as many others will tell you, this is not always the case in the real world. It sounds like your “prodigal son” is a “spendthrift” – what the dictionary defines as a person who spends money recklessly or foolishly. If that sounds about right, then a Spendthrift Trust may be the answer to your dilemma.

What it is…

A Spendthrift Trust is a type of trust account that is overseen by a trustee and controls the assets you leave to you heirs. The beneficiary (the spendthrift) cannot spend the money before he receives a distribution and cannot use the trust as collateral. This keeps the assets of the trust secure generating interest and other income for years. Even when an heir is responsible, a spendthrift provision is a good idea because it protects the trust if a beneficiary is ever sued and a judgment creditor tries to attach the beneficiary’s interest in the trust.

How it works…

The beneficiary receives an allowance of sorts. The trustee has the authority to decide what payments are necessary as specified in the trust agreement. It is important to be realistic in setting the annual distribution. It should cover “necessaries” (food, shelter, clothing, and transportation for example) as long as they are not extravagant. Most courts will also permit the use of Spendthrift Trust assets to satisfy awards of child support and alimony.

In order to curtail abuses, many states use the doctrine of "surplus income" to allow creditors the ability to seize trust income that exceeds what is necessary to support the beneficiary. This excess will be awarded to the creditor and paid directly by the trustee. So, providing a lavish lifestyle through this type of trust will not do any favors for your son.

The trust will not be considered as protected unless it is clear from the beginning that you intend for it to be a Spendthrift Trust. Therefore, it is important to include language in the trust agreement showing that you intended the trust be specified as a spendthrift from its inception. This provision is irrevocable and again protects the beneficiary and the assets from creditors who may attempt to attach the assets in the trust before they are distributed. Words that indicate your intention to impose a direct restraint on the transferability of his interest can be used to create a Spendthrift Trust.

What it does and doesn’t protect…

While the asset of the trust and future payments are protected from creditors, a Spendthrift Trust does not limit the rights of creditors to money or property received by your son from the trustee. So, if you have set up a trust that pays $25,000 per year for your son’s maintenance, a creditor could seek to have the money your son has already received applied to satisfy his debt to them. Claims to future payments are controlled. So, the creditors cannot take the $25,000 he is paid in the subsequent year until it is actually paid to him. By restricting your son so that he can do nothing with income until it is paid into his hands by the trustee, it is more likely that he will be protected (at least to some extent) against poverty (aka living in a tepee eating cat food).

You also need to be aware that certain classes of people can penetrate the protection of a Spendthrift Trust. Based on the “public policy” argument, these groups can gain access to a beneficiary’s interest in the trust. These classes include persons your son is legally bound to support such as a spouse or children; persons who render necessary personal services to your son such as a physician; and persons who preserve your son’s interest in the trust. Tort claims against you son as well as claims by the government such as income tax are also not subject to spendthrift provisions.

It is critical that you seek advice from a legal and/or financial advisor well versed in your state’s restrictions on Spendthrift Trusts. States that do not authorize such trusts or provisions will void a spendthrift provision so that the beneficiary can transfer his or her rights and the creditors can attach the right to future income.

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