Despite its name, the purpose of a spendthrift trust isn’t just to protect profligate heirs from themselves. Adding spendthrift language to a trust benefiting one’s heirs can help safeguard assets from their creditors, or in the event of relationship changes.
Effects of spendthrift language
With assistance from an estate planning advisor or attorney, set up the trust according to state laws and transfer assets to the trust account. Generally, the assets will consist of securities such as stocks, bonds and mutual funds, and possibly real estate and cash. The appointed trustee then manages the assets.
Essentially, the terms of the trust — the spendthrift language — restrict the beneficiary’s ability to access funds in the account. Therefore, the beneficiary can’t invade the trust to indulge in a wild spending spree or sink money into a foolhardy business venture. Similarly, the trust assets can’t be reached by any of the beneficiary’s creditors.
Instead of having direct access to funds, the beneficiary usually receives payments from the trust on a regular basis or “as needed” based on the determination of the trustee. For example, the trust might call for two scheduled payments to be made during the year for the fall and spring semesters at the beneficiary’s college. The trustee is guided by the terms of the trust and must adhere to fiduciary standards.
Be aware that the protection isn’t absolute. Once the beneficiary receives a cash payment, he or she has full control over that amount. The money can be spent without restriction and may be attached by creditors.
Choose a trustee carefully
The role of the trustee obviously is an important one. Depending on the trust terms, he or she may be responsible for making scheduled payments or have wide discretion as to whether funds should be paid, and how much and when.
For instance, the trust may empower the trustee to make set payments or retain discretion over amounts to be paid or even over whether there should be any payment at all. Or maybe the trustee is directed to pay a specified percentage of the trust assets, so the payouts fluctuate depending on investment performance. In the same vein, the trustee may be authorized to withhold payment upon the happening of specific events (such as if the beneficiary exceeds a debt threshold or has to declare bankruptcy).
Designating the trustee is an important consideration, especially in situations where he or she will have broad control. Although it’s not illegal to name yourself as trustee, this is generally not recommended. Often, the trustee will be an attorney, CPA, financial planner or investment advisor, or someone else with the requisite experience and financial acumen.
Be aware, however, that you aren’t required to name someone with a particular background. You may prefer to name a relative or friend, who’ll then have the responsibility to hire the appropriate professionals. You should also name a successor trustee (or multiple successors) in the event the designated trustee dies before the end of the term or otherwise becomes incapable of handling these duties.
There are several other critical aspects relating to crafting a spendthrift trust. For example, you must establish how and when the trust should terminate. The trust could be set up for a term of years, or termination may occur upon a specific event (such as a child reaching the age of majority).
Finally, try to anticipate other possibilities, such as enactment of tax law changes, that could affect a spendthrift trust.
Don’t try this at home
For some, protecting their wealth after they’ve transferred it to loved ones is just as important as reducing the tax liability on the transfer. But beware: Drafting a spendthrift trust isn’t a do-it-yourself proposition. Consult your estate planning advisor for assistance.