Many of my clients want to use a trust to manage and distribute their estate assets; however, they also want to make sure those assets are protected even after they reach their intended beneficiaries. One estate planning tool that can be used to accomplish both goals is the use of an irrevocable asset protection or inheritance trust. When used appropriately, this kind of ” spendthrift trust” can protect assets held in a trust from misuse by beneficiaries or in the alternative or in addition, to protect them from attachment by creditors or exposure to a divorce.
Trust Agreement Basics
At its most basic, trust is a relationship whereby property is held by one party for the benefit of another. The terms and provisions of a trust are reduced to writing in a document referred to as a “trust agreement.” Trusts are broadly divided into various forms of trust created for use during the life of the owner of the property transferred to the trust (this includes what are commonly referred to as “living trusts”) and testamentary trusts arising and being funded only upon the death of the original property owner. Trusts created during someone’s life can be divided further in revocable trusts and irrevocable trusts, while testamentary trusts are typically irrevocable.
I encourage my clients to think of their testamentary instructions as irrevocable — unchangeable by anyone else — even when that irrevocable instruction is to leave the assets in a revocable form for the beneficiary. For example, I might have a Will, which by its nature is irrevocable upon my death, which leaves all of my assets to my wife, outright, essentially leaving her free to do anything she might want with the assets. I might in the alternative leave an irrevocable instruction that they assets go into a trust for my spouse or my spouse and children. Typically (although not always) this trust would be irrevocable, and one of my goals in this arrangement is to ensue that my goals regarding use and management of the assets and also my intention with respect to the distribution of whatever is left upon my wife’s death will be honored.
This testamentary irrevocable trust might also serve other purposes. In fact, the low hanging fruit of good estate planning is that it is quite easy to set up a structure in which one or more beneficiaries of your estate receive their inheritance in a trust which allows them to use the assets for whatever they might need, for what their own children might need, and yet protect their assets in full from their own poor decisions or simply bad luck.
What Is a Spendthrift Clause?
These asset protection trusts rely on what is called a spendthrift clause. A spendthrift clause, or a spendthrift trust, refers to a clause within a trust or a trust agreement in general that is aimed at preventing the creditors of beneficiaries of the trust from taking the assets to satisfy debts or tax obligations of the beneficiaries. We call this a spendthrift trust, even though the beneficiary is not a spendthrift. For example, many of my clients whose adult children are in business or professions which expose them to potential liability choose to use a spendthrift trust for these children.
Of course, if the beneficiary actual makes poor decisions, exposing himself or herself to liability, then a key feature of this trust would be to appoint a third party to serve as Trustee, making the most important decisions about management and distribution of the trust assets, based on instructions in the Trust Agreement defining the intentional of the original property owner — the parent in my example.
Very specific language must be used to create a spendthrift clause; however, when drafted properly, a spendthrift clause will prevent a beneficiary from spending the trust funds frivolously as well as prevent borrowing against those funds or encumbering the funds in any way. A spendthrift clause will prevent creditors of the beneficiary from accessing the trust funds to pay debts of the beneficiary.
Because the creator of a trust has wide latitude when creating the trust terms, those terms to define how a beneficiary may use trust funds and may direct the Trustee to make distributions directly to a landlord, school, or physician instead of to the actual beneficiary. This is another way we can protect against the possibility of a beneficiary squandering trust assets.
State laws govern most aspects of trust agreements, including the validity of a spendthrift clause as well as the protection offered by the clause. Most states, including North Carolina, have laws that recognize the validity of a spendthrift provision to prevent both voluntary and involuntary transfers of a beneficiary’s interest in the trust. An “involuntary” transfer refers to a creditor attaching a lien to the beneficiary’s interest.
It is common to have a spendthrift clause in the boiler plate of a Trust Agreement, and this is a good thing. Still, I think that it is critically important that if you think this kind of protection might be of value for any or all of your beneficiaries that you have an experienced estate planning attorney construct a trust agreement that is customized to meet your goals and the particular situations of your beneficiaries.
Are There Limits to the Protection Offered by a Spendthrift Clause?
While a spendthrift clause can provide the beneficiary of a trust a great deal of protection against the loss of trust assets, there are limits. Some states, for example, will not extend the protection offered by a spendthrift clause to debts such child or spousal support as well as government debts such as taxes. Some states also limit the dollar value of assets that can be protected by a spendthrift provision in a trust agreement. North Carolina’s exceptions state that “a beneficiary’s child who has a judgment or court order against the beneficiary for support or maintenance may obtain from a court an order attaching present or future distributions to or for the benefit of the beneficiary. The court may limit the award to relief that is appropriate under the circumstances.”
Contact a Chapel Hill Durham area Trust Attorney
If you have additional questions or concerns regarding spendthrift provisions in a trust, please contact a Chapel Hill, Durham, Raleigh area trust attorney at Clarity Legal Group by calling us at 919-484-0012 or contactus online.