Spendthrift Trusts Explained: Protecting Beneficiaries and Assets from Creditors

What if we told you there was a way to provide creditor protection for your beneficiaries and to protect your beneficiaries from their own bad choices? Additionally, what if we said you could do this without any special legalese in your trust, but done in plain English where it’s made clear what you want? Below, we’ll discuss spendthrift provisions and creditor protections for your living trust.

What is Spendthrift?

A spendthrift trust, or a trust with a spendthrift provision in it, is a trust which, by its terms, prevents a beneficiary’s voluntary or involuntary transfer of trust assets and requires no special wording to establish so long as your intent is clear as the settlor, or the one making the trust. We discuss voluntary and involuntary in greater detail below, but generally speaking, this type of trust or provision makes it so that if someone is a beneficiary of the trust, their creditors cannot collect from the trust that beneficiary’s share of the trust estate to satisfy that beneficiary’s debts.

For example, a son is a beneficiary of his mom’s trust with a spendthrift provision therein, and he has credit card debt going into collections. So long as money has not been distributed from the trust to the son, the son’s creditors cannot look to the trust to satisfy his debts. As there is a valid spendthrift provision, creditors are barred from reaching the beneficiary’s interest in the trust, unless or until the monies are paid to the beneficiary from the trust. As you can imagine, this is a powerful tool to have in your estate plan to protect your beneficiaries, likely from themselves. However, there are some exceptions, but first we will differentiate voluntary vs involuntary actions by the beneficiary before jumping into exceptions.

Voluntary vs. Involuntary Actions by a Beneficiary

By voluntary transfer, we mean something done by the beneficiary themselves to cause a debt to be owed. Some examples include taking out a loan or agreeing to guarantee someone else’s loan. By involuntary, we’re referring to debts that are due for repayment due to a creditor’s actions like filing a lien or getting a judgement from a court. In essence, debts the beneficiary either agreed to or debts to which they have become liable for whatever reason.

Spendthrift Exceptions: Breakthrough Creditors

As discussed above, a spendthrift provision is not 100% bulletproof. There are 5 exceptions:

1. Government Debts: the first exception is for the government, both federal and state, in order to settle debts to the government such as unpaid taxes.

2. Spousal Support: The second is a spouse, or likely an ex-spouse, seeking spousal support.

3. Child Support: Third is where a child is seeking child support.

4. Those Who Preserve the Interest of the Beneficiary: Fourth is an exception for someone who “preserves the interest” of a beneficiary, which for example, could be an attorney. We are sure it’s no mystery who wrote that exception into law.

5. Catch-All: The fifth exception is a bit of a catch-all, that being a provider of necessities. An example would be someone who provided something like food, shelter, clothing, and medical care. However, outside of emergency medical attention, it would likely take a lot to show that something provided to some was such an important necessity so as to allow collecting against money the beneficiary cannot even access themselves yet.

No Protection for Settlor’s Retain Interest

A question that may have come to mind for you is that of your own interest in the property you put in your trust. If you can protect your beneficiaries from their own creditors, can you protect yourself from your own creditors? Unfortunately, or fortunately if you’re a creditor, you as the owner cannot create a spendthrift trust for yourself yet also retain an interest in the property and management of the assets in the trust. This is called a self-settled trust and is illegal unless you live in Alaska, Delaware, Hawaii, Michigan, Mississippi, Missouri, Nevada, or New Hampshire.

You may have heard about self-settled trusts, but under a different name: an asset protection trust. In essence, this type of trust is one wherein you make the trust, you put your assets into the trust, you manage the trust as the trustee, and creditors can no longer reach your assets in the trust for a debt you personally owe (which would be different than a debt owed by the trust). The only way to do some type of asset protection in a state other than those listed above would be to create a trust with a spendthrift provision in it but lose the retained interest of the assets in the trust, such as putting a house in the trust, only retaining a right to occupy it, and not being allowed to pull the asset out of the trust. There is one allowed way to do a self-settled trust in California, but it entails making the state itself the beneficiary and a topic for a discussion of its own.

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