As mentioned above, trusts are used to achieve certain estate planning goals, most commonly
- Probate avoidance;
- Incapacity planning;
- Minimizing estate and gift taxes; and
- Asset protection
When it comes to asset protection, a special kind of trust, known as a spendthrift trust, is the ideal structure. A spendthrift trust is an irrevocable trust that protects the trust assets by placing control of them beyond the reach of a beneficiary and his or her creditors.
A spendthrift trust is created by including language in the trust agreement that restricts the beneficiary’s access to the trust assets and prevents them from assigning their interest in the trust to a creditor, preventing the creditor from attaching the trust assets. This is referred to as a spendthrift provision.
The purpose of a spendthrift provision is to protect against a beneficiary gaining access to the trust assets and squandering them due to mismanagement, bad habits, or poor choices. The spendthrift provision also protects the trust assets from a beneficiary's unsecured creditors. An example of an unsecured creditor is a judgment creditor or a lawsuit creditor.
A spendthrift provision can be utilized by anyone who wants to leave significant wealth to a loved one while protecting it from being lost due to the loved one’s penchant for mishandling money; drug, alcohol or gambling addiction; divorce; indebtedness; getting sued; and other threats. Spendthrift provisions are also utilized by individuals whose professions expose them to potential liabilities.
Some states have laws that favor the use of spendthrift trusts for asset protection. Often, you can create a spendthrift trust with yourself as the beneficiary and, thereby, protect your own assets from creditors. This type of spendthrift trust is referred to as a domestic asset protection trust (DAPT).
Every state that allows this type of spendthrift trusts to be created has its own rules. However, for a DAPT to be valid, it must usually meet the following legal requirements:
- It cannot be created with fraudulent intentions;
- It must be in compliance with the law and otherwise be legitimate;
- It must include a provision that restricts the beneficiary from voluntarily or involuntarily transferring his or her interest in the trust; and
- It must clearly indicate the settlor’s intent to impose those restrictions.
There may also be other requirements, depending on the state in which the DAPT is established, that an experienced estate planning attorney can make you aware of when assisting you with setting up the trust.
When a spendthrift trust is drafted properly, the beneficiary can receive regular distributions from the trust, but creditors will be unable to reach any of the assets that have been transferred into the trust. The law, however, does not protect any transfers to a spendthrift trust that were made for fraudulent purposes, which violate a court order, or that were made to avoid a legal obligation.
What's more, there is usually a look-back period during which creditors can challenge a transfer to or from your spendthrift trust. This look-back period is usually two years, but maybe shorter if notice is given.
Spendthrift trusts are excellent for protecting a loved one’s inheritance and for asset protection. However, they must be drafted expertly and in compliance with specific legal requirements. If not, the spendthrift trust will be compromised, and the trust assets will be exposed to lawsuits and creditors.
To learn more about spendthrift trust, contact a qualified estate planning attorney. An experienced estate planning attorney can ensure that your spendthrift trust is drafted properly to effectively protect the assets it holds.