You may want to take care of your children in your will but suspect that they would blow through their inheritance in just a few years. That’s when a spendthrift trust comes in handy. Also called a spendthrift provision, this type of trust has restrictions that protect heirs from both themselves and potential creditors.
What Is a Spendthrift Trust?
A spendthrift trust allows you to leave funds to a beneficiary without giving full control over those funds. Instead, an independent trustee is given the authority to distribute funds for the benefit of a beneficiary.
“A spendthrift trust is basically set up to protect your beneficiary from squandering the wealth that was bequeathed to them or was left to them,” says Sabine Franco, chief esquire of The Ambitious Legacy Firm in Hempstead, New York. “Basically, it prevents waste or injury to an immature heir, so that they don’t lose the inheritance, and it also protects them from being taken advantage of (by) others.”
[READ: States With Estate and Inheritance Taxes.]
How to Set Up a Spendthrift Trust
Sit down with an estate attorney and talk in detail about your concerns. The attorney can write certain rules into the trust. For example, an heir may be required to reach a certain age before starting to receive payments, or you might require that the heir receive installments at certain life stages.
“It’s really about evaluating the particulars of their life, their loved ones, their assets, and then coming up with a plan on how to distribute the assets and when that should be done,” Franco says.
For example, if the parents have a $10 million estate, they may want to make sure their 18- and 20-year-old children are taken care of, but they don’t want them to get $5 million each all at once. They can create a spendthrift trust (or a spendthrift provision) that might state the children will receive the first payments when they graduate college and later payments when they marry, have children or even buy a home. The concern could also be to protect immature heirs from others, especially creditors.
How to Decide Whether a Spendthrift Trust Is Right for You
If you have an immature, irresponsible or underage heir or someone to whom you want to leave an inheritance, a spendthrift trust can give you some control over how and when the money is spent.
A spendthrift provision can also limit creditors’ access to the funds. “The goal is to keep other people from accessing the funds,” says Jennifer Belmont Jennings, attorney at MGD Law in St. Louis. “It’s the goal of the original trust creator to protect their beneficiary’s assets from other people. It could be a creditor or even an ex-spouse.”
[Read: Estate Planning Tips to Keep Your Money in the Family.]
Pros and Cons of a Spendthrift Trust
The pros: You can ensure your most vulnerable beneficiary is safeguarded.
“If I have a child who is a very, very trusting person, I might be concerned that they’re going to be scammed out of their inheritance,” says Ann-Margaret Carrozza, a New York attorney specializing in elder law and estate planning. “So I want to safeguard it within the structure of a spendthrift trust.”
The cons: A spendthrift trust is expensive, says Brian Copeland, partner and director of financial planning at Hightower Wealth Advisors in St. Louis.
“If you just pass assets on directly to beneficiaries, there’s typically no extra cost to manage or deal with that. With a spendthrift trust, you’re paying an attorney to create and draft it. It ends up with its own tax ID number, so it almost acts like a separate bucket, which means that there’s maintenance ongoing and there are separate tax returns that need to be filed,” Copeland says. “So, it’s a little bit more complicated and a little bit more expensive to maintain it.”
Do the Laws Differ From State to State?
Yes. There are different types of spendthrift trusts, “and every state has different laws, which makes it hard,” Copeland says. “That’s why I think it’s very important to work with a qualified attorney.” He says a basic spendthrift trust is generally accepted in most states, but the level of protection may differ from state to state.
Carrozza, a former New York State legislator, says one side of the argument is that “we shouldn’t make it so strong that the beneficiary can shirk his or her child support obligations, for example.”
Also, she says, most states limit the protections allowed for certain types of spendthrift trusts called self-settled trusts. “If a parent is setting it up for their child, you’re going to have more protection with that trust in every state,” she says. But if the trust is set up by the beneficiary with his or her own funds from, say, an accident settlement, and a court believes the trust was set up to delay, hinder or defraud creditors, most states will offer less protection from creditors.
Still, Carrozza says, a handful of states pride themselves on having the strongest protection for spendthrift trusts, including self-settled trusts. Those include Alaska and Nevada.
[Read: 5 Reasons to Make an Estate Plan.]
The Importance of Selecting the Right Trustee
One of the keys to setting up a successful spendthrift trust is selecting the right person to be the trustee. That person can have some discretion when distributing the funds, so it needs to be someone you can trust over the long term.
“That’s why going to an estate planning attorney who truly is an expert in that field is so important,” Jennings says. “You want to go to an estate planning attorney who does this for a living, who deals with high-net-worth clients, who deals with drafting these provisions and is familiar with state law.”
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What Is a Spendthrift Trust? originally appeared on usnews.com
Update 07/13/23: This story was published at an earlier date and has been updated with new information.
