Posted On: JANUARY 2024
Is protecting your wealth after it’s been transferred to beneficiaries just as important to you as reducing the tax liability on the transfers? If so, attaching spendthrift language to a trust can provide you peace of mind that your hard-earned wealth won’t be frivolously spent by your heirs or seized by their creditors. Indeed, the benefit of a spendthrift trust is that it restricts a beneficiary’s ability to access trust funds.
How does a spendthrift trust restrict access?
Briefly stated, a beneficiary can’t tap directly into the principal or transfer rights to it to someone else. This can also deny access to creditors or a divorced spouse of a beneficiary.
Instead, the trust beneficiary relies on the trustee to provide payments based on the trust’s terms. This could be in the form of regular periodic payouts or on an “as needed” basis. The trust document will spell out the nature and frequency, if any, of the payments. Once a payment has been made to a beneficiary, the money then becomes fair game to any creditors.
Note that a spendthrift trust isn’t designed primarily for tax-reduction purposes. Typically, this trust type is most beneficial when you want to leave money or property to a family member but worry that he or she may squander the inheritance. For example, you might think that the beneficiary doesn’t handle money well based on experience or that he or she could easily be defrauded, has had prior run-ins with creditors, or suffers from an addiction that may result in a substantial loss of funds.
If any of these scenarios is a possibility, a spendthrift trust can provide asset protection. It enables the designated trustee to make funds available for the beneficiary without the risk of misuse or overspending. But that brings up another critical issue.
What’s the trustee’s role?
Depending on the trust terms, the trustee may be responsible for making scheduled payments or have wide discretion as to whether funds should be paid, 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 decide if there should even be any payment at all. Or perhaps the trustee will be directed to pay a specified percentage of the trust assets, so the payouts fluctuate, depending on investment performance. Similarly, the trustee may be authorized to withhold payment upon the occurrence of certain events (for example, if the beneficiary exceeds a debt threshold or declares bankruptcy).
The designation of the trustee can take on even greater significance if you expect to provide this person with broad discretion. Frequently, the trustee will be a CPA, attorney, financial planner or investment advisor, or someone else with the requisite experience and financial know-how. You should also name a successor trustee in the event the designated trustee passes away before the term ends or otherwise becomes incapable of handling the duties.
What are other considerations?
Be aware that the protection offered by a spendthrift trust isn’t absolute. Depending on applicable law, it may be possible for government agencies to reach the trust assets — to satisfy a tax obligation, for example.
It’s also important to establish how and when the trust should terminate. It could be set up for a term of years or for termination to occur upon a stated event, such as a child reaching the age of majority.
Turn to a professional
Unless you’re an experienced legal or financial professional, drafting a spendthrift trust isn’t a do-it-yourself proposition. We can ensure your trust satisfies all the legal formalities.
© 2024