A spendthrift trust is any trust that contains clauses specifically aimed at preventing the beneficiaries from squandering their inheritance. People who want to leave substantial amounts of money to their adult children or grandchildren—but don’t trust them to manage it wisely—often use spendthrift trusts.
How Spendthrift Provisions Work
The trust prohibits the beneficiaries (the people who benefit from the trust) from spending or borrowing against the trust funds. Spendthrift language is also intended to prevent creditors from going after trust funds to pay what a beneficiary owes them. To be effective, the trust must contain very specific language. Here’s a typical spendthrift provision you might find in a document creating such a trust:
Except as otherwise provided in this trust agreement, all principal or income that is payable, or will become payable, to the beneficiary of any trust created by this agreement shall not be subject to anticipation, assignment, pledge, sale, or transfer in any manner. No beneficiary shall have the power to anticipate or encumber any such interest. No such interest, while in the possession of the trustee, shall be liable for, or subject to, the debts, contracts, obligations, liabilities, or torts of any beneficiary. Such interests shall also be free from any claim, control, or interference of the spouse of a married beneficiary, or the parent of a beneficiary.
The statutes of many states recognize spendthrift trusts, and say that spendthrift provisions are valid to prevent both "voluntary and involuntary" transfers of the beneficiary’s interest in the trust. In other words, the beneficiary can’t spend or pledge the trust money, and creditors can’t seize it.
You can’t stiff creditors by setting up a spendthrift trust for yourself. It only works when you name someone else as the beneficiary.
Debts a Spendthrift Trust Can’t Avoid
It isn’t possible to lock up trust assets entirely. Under most states’ laws, assets held in trust must be used to pay certain kinds of obligations, including child support, support of a spouse or former spouse, and debts incurred for necessities of life, such as food or shelter. Government claims may also be enforceable against trust assets.
For example, a Delaware woman went to court seeking the spousal support due her under a separation agreement with her husband, who was the beneficiary of a spendthrift trust. The court concluded that she was not a "creditor" as defined in the state statute allowing spendthrift trusts, and that she was entitled to funds from the trust to pay her what she was owed. (Garretson v. Garretson, 306 A.2d 737, Del. 1973.)
State law may also put a limit on the amount of money that can be protected from creditors. For example, in Oklahoma, creditors can take any income from trust property that exceeds $25,000 per year. (Okla. Stat. Ann. § 175.25.) But only a very large trust would generate $25,000 of income in a year.
The Trustee’s Role
The trustee is in charge of the trust funds and doles them out according to the terms of the trust. A trustee may make payments directly to the beneficiary, if the trust allows or requires it. A trust document may direct the trustee to release all or part of the trust funds to a beneficiary at a certain date or event—for example, when the beneficiary turns 25 or graduates from college. In that case, the trustee must follow the terms of the trust and turn over the money, even if it seems very likely that the beneficiary will promptly lose it.
With a trust that is designed to keep money out of the hands of an improvident beneficiary, however, it’s likely that most of the disbursements will be made to others—schools, landlords, and so on—on the beneficiary’s behalf. If the trustee does give trust money directly to beneficiaries, they are free to spend it however they wish.
This information is not intended to be tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor.
