What is a Spendthrift Trust?

What are your options when you want to leave a portion of your estate to a relative or friend, but you don't trust their financial judgment or are worried that they may have creditors? A spendthrift trust helps you meet this difficult challenge. It allows you to control how and when you transfer your assets to a financially unpredictable person. You have the flexibility to ensure that your assets remain a lasting source of income regardless of your beneficiary's spendthrift habits, whether they get divorced or have creditors that would want to get their hands on money you bequeath to them through a Will (or outright / outside of a properly-drafted trust). 

How Does A Spendthrift Trust Work? 

A spendthrift trust is particularly useful when your beneficiary is young, unpredictable, or financially imprudent. It derives its name from the word spendthrift, defined by Merriam-Webster as "given to spending money freely or foolishly." When you're setting its terms, it usually allows you more flexibility than a will. It's a revocable living trust, so you can't usually alter the terms after you complete the process. But the trust becomes irrevocable upon your passing.

A spendthrift trust functions in a way that provides your beneficiary an income without granting full access to all the trust funds. When you place your assets in a trust, your appointed trustee controls them and distributes them in accordance with your instructions. When properly executed, your distribution guidelines remain in place, even after your death. 

A spendthrift trust is a legal entity that becomes the owner of the assets. That designation helps it perform one of its most important roles. It protects the assets from the beneficiary's imprudent actions. A beneficiary can't access them, use them as collateral, or assign them to someone else for any reason. The trust also protects assets from your beneficiary's present or future creditors and collection actions. 

Establishing the Terms of Your Trust

When you include specific spendthrift language, it provides elements of protection and control. As the grantor or trust creator, you decide how to establish the trust, and you designate the assets you wish to give to your beneficiaries. When you place your assets in the trust, they become the trust principal which generates future trust income. 

You decide how and when the trust distributes your assets to your beneficiary. For example, you may specify periodic distributions based on your beneficiary's age or circumstances. You may allow distributions of interest only or portions of the principal and the interest.

When you establish your spendthrift trust, you appoint a trustee to manage and distribute your assets based on the role, instructions, and desired goals you set. You may choose to allow the trustee to make administrative decisions at his or her discretion. You may also appoint a successor trustee who will assume the fiduciary responsibilities if the original trustee becomes incapacitated or dies.

Tax Considerations

A trust is an entity with potential tax liabilities based on Federal Income Tax Code, 26 USC Subtitle A, CHAPTER 1, Subchapter J: Estates, Trusts, Beneficiaries, and Decedents. The trustee must file an income tax return on behalf of the trust to pay any taxes owed on earned income. If necessary, the trustee may obtain a separate tax identification number for the trust - but most revocable trusts are opened with the grantor (i.e. person who creates the trust)’s social security number. Goods, services, and cash paid to the beneficiary are considered taxable income. The beneficiary is responsible for filing and paying his own taxes on any distribution.

Do I Need A Spendthrift Trust?

Before you execute the trust paperwork, you must be certain that it's the right option for you and your circumstances. A spendthrift trust, upon your passing,  becomes an irrevocable arrangement. 

You can create an irrevocable trust while alive if you are interested in your own asset protection. 

It creates an entity that's legally separate from you and your beneficiary. You relinquish authority and control of your assets to the trust and to the trustee. If you have any doubts about the process, an estate planning attorney can discuss other options. Here are a few things to consider. 

  • Your trustee will have complete authority to control your assets. You must be certain that he or she is capable of executing the fiduciary responsibilities.
  • If you create a spendthrift trust solely because your beneficiary is young and irresponsible, you should understand that your beneficiary's circumstances might change as he or she ages.
  • If you change your mind about your spendthrift trust, you should know ahead of time whether you have the option to change it. 
  • If your jurisdiction does allow you to modify or dissolve your trust, you should know ahead of time if the change will involve a complex process. 

How Can An Estate Planning Attorney Help With A Spendthrift Trust? 

If you need more information about spendthrift trusts, contact an estate planning attorney. An attorney can explain the mechanics of a trust and help you understand any legal or tax implications. Attorneys can explain any jurisdiction-specific laws or codes that apply to setting up your trust or appointing a trustee. You can also learn more about your right to dissolve or modify a trust if you change your mind. 

Reach out today to begin discussing your estate plan and see if a spendthrift trust might be a good option for you.



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FAQ

Frequently Asked Questions

Can a spendthrift trust be broken?
So long as the trust is an irrevocable trust (like almost all spendthrift trusts are) it cannot be modified or broken by the grantor in any way. In creating the trust, they have surrendered their legal rights to the assets in question, and as such cannot change how they are managed.
How does a spendthrift trust work?
A spendthrift trust is a type of irrevocable trust that puts strict limitations on how and when the beneficiary can access the assets held in the trust. Spendthrift trusts are sometimes a good option for leaving assets to a loved one who is not great at handling finances or who could fall prey to creditors or otherwise be defrauded out of the assets.
What does irrevocable trust mean?
An irrevocable trust is a type of trust document that cannot be changed. This means that in order to modify or terminate any of the terms of the trust, the grantor must have permission from the named beneficiaries. In some cases, choosing an irrevocable trust is a good decision, and in other situations giving up this much legal control over the assets in question is not something that the grantor would like to do. An estate planning lawyer can provide advice based on a person’s particular situation.
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