Spendthrift trust

Wills, trusts and estates

Part of the common law series

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Governing doctrines Pour-over will Cy-près doctrine Trusts and conflict of laws

Estate administration

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Related topics

Advance directive (Living will) Totten trust

Other common law areas

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A spendthrift trust is a trust that is created for the benefit of a person (often because he or she is unable to control spending) that gives an independent trustee full authority to make decisions as to how the trust funds may be spent for the benefit of the beneficiary. Creditors of the beneficiary generally cannot reach the funds in the trust, and the funds are not actually under the control of the beneficiary.

The creator of a trust (whether or not it is a spendthrift trust) is sometimes called the "trustor", "grantor" or "settlor" of the trust. A trust often will not be treated as a spendthrift trust unless the trust agreement contains language showing that the creator intended the trust to qualify as spendthrift. This is what is known as a spendthrift clause or spendthrift provision.

A spendthrift provision in an irrevocable trust prevents creditors from attaching the interest of the beneficiary in the trust before that interest (cash or property) is actually distributed to him or her. Most well drafted irrevocable trusts contain spendthrift provisions even though the beneficiaries are not known to be spendthrifts. This is because such a provision protects the trust and the beneficiary in the event a beneficiary is sued and a judgment creditor attempts to attach the beneficiary's interest in the trust.

Example: Texas law

For example, the Texas Property Code provides:

(a) A settlor may provide in the terms of the trust that the interest of a beneficiary in the income or in the principal or in both may not be voluntarily or involuntarily transferred before payment or delivery of the interest to the beneficiary by the trustee.^[1]

A clause in the terms of a trust agreement that complies with the above-quoted statute is an example of what the law calls an "anti-alienation provision".

To continue with the example of the Texas law, the Texas Property Code further provides:

(b) A declaration in a trust instrument that the interest of a beneficiary shall be held subject to a "spendthrift trust" is sufficient to restrain voluntary or involuntary alienation of the interest by a beneficiary to the maximum extent permitted by this subtitle.

(c) A trust containing terms authorized under Subsection (a) or (b) of this section may be referred to as a spendthrift trust.^[2]

The above-quoted language essentially means that a trust instrument does not (at least, in Texas) have to contain complex legal jargon to qualify the trust as "spendthrift"; simply using the word "spendthrift" in the trust document may be sufficient.

Necessaries, child support and alimony

Some creditors may compel payment out of the trust - particularly those who supply the beneficiary with "necessaries" (usually food and shelter, but sometimes clothing and transportation, if these are not extravagant). Most jurisdictions also permit the invasion of spendthrift trust assets to satisfy awards of child support and alimony.

Trusts where the beneficiary is also the creator

A trust created by an individual for his or her own benefit is sometimes called a "self-settled trust". If the creator of a self-settled trust is also a beneficiary of the trust, a particular problem in the context of protection of creditors and prevention of fraud is presented: the danger that the creator of the trust is trying to defraud creditors.

The general rule: Self-settled trusts do not protect the trust creator

To prevent individuals from creating trusts to defeat their own creditors, the laws of most states provide that a spendthrift clause in a trust document does not protect the beneficiary to the extent that the beneficiary is also the person who created the trust. For example, Texas law provides:

(d) If the settlor is also a beneficiary of the trust, a provision restraining the voluntary or involuntary transfer of his beneficial interest does not prevent his creditors from satisfying claims from his interest in the trust estate.^[3]

Further, laws in some states (like Texas) are worded so broadly that anyone transferring property to the trust might be deemed to be a "creator" (i.e., settlor, grantor, or trustor), not merely the person or persons who originally set up the trust.

The exceptions: DAPT states

However, several states have changed their laws to provide that a person may create a self-settled spendthrift trust (i.e., a spendthrift trust for his or her own benefit). Such trusts are also called Domestic Asset Protection Trusts ("DAPT"), and sometimes informally called "Alaska trusts", as Alaska was a pioneer in allowing this kind of spendthrift trust. However, because of the danger of the misuse of Alaska trusts to defraud creditors, the legality of such trusts (to the extent that they purport to protect the trust share of a beneficiary who is also a creator of the trust) is uncertain in the states not allowing self-settled spendthrift trusts.

Nevada also changed its laws, effective October 1, 1999, to provide even superior self-settled spendthrift trust laws to those of Alaska. Nevada's law generally protects the trust creator two years after transferring assets to the trust, whereas Alaska law generally requires a four-year waiting period to obtain the protection. Nevada is also seen by some Settlors as being more desirable, since a new law passed in 2009 allows for the Settlor to serve as trustee of his or her own Nevada trust, as long as such trustee cannot authorize distributions to be made from the trust back to himself or herself.

In addition to Nevada and Alaska, it should also be noted that the following other states now have a DAPT statute: Delaware, South Dakota, Wyoming, Tennessee, Utah, Oklahoma, Colorado, Missouri, Rhode Island and New Hampshire.

Notes