Many people wish to leave a large inheritance to their children. This is one of the greatest generational wealth-building tools in our society. However, what does one do when the next generation is less than responsible? Or, more commonly, what does one do when an adult child is mentally impaired in some way? To leave a large amount of money to such an individual would spell almost certain disaster, because much of the money could be lost in a short period of time. Likewise, an irresponsible or incompetent person could easily be taken advantage of, thereby losing the bulk of his or her inheritance. The answer for some is a spendthrift trust.
What is a spendthrift trust?
Trusts, unlike wills, offer the creator the option of controlling how money is dispersed and spent for as long as funds remain. This “eternal control” offers many individuals greater comfort and peace of mind, knowing that their heirs will be provided for in the best way possible.
A spendthrift differs in a few respects. First, it is created solely for the benefit of a person who is unable to control his or her own spending, regardless of the reason. Second, due to that inability, power is given to a trustee to decide how and when money is distributed to that person. Third, there are specific restrictions on what assets may be used to pay for the debts of the individual for whom it is established. Finally, any trust can contain a spendthrift provision or clause, thereby establishing a trust within a trust. This is often used where there are multiple heirs provided for in the trust, yet one of them requires the spendthrift provision. Let’s look closer at each of these.
Sole benefit of the heir requiring spendthrift protection
This rule simply means that funds placed in such a trust may not be used to pay for things that are not necessary for the spendthrift heir. As explained above, however, if the trust contains provisions for other heirs, this restriction would likely only apply to the particular subtrust created for the benefit of this particular heir.
Trustee’s role in protecting the spendthrift heir
A trustee is under a strict fiduciary obligation, much like the obligation an attorney has to protect client funds. Thus, the trustee must closely guard against abuse and misuse of funds. This is usually a service provided by another family member or heir, yet many families are now choosing to pay a slightly higher fee to use the services of a professional trustee or bank and trust company.
Restriction on uses and liability
Many times, an heir may go bankrupt or become financially liable for a large debt that he or she cannot pay. Creditors naturally would like to be paid, so they may attempt to collect from the trust. However, as long as the trust is properly formed and drafted, the spendthrift trust should make it clear that it may not be used to pay the debts and liabilities of the heir. This often thwarts creditors’ attempts to seize trust assets, thereby protecting the money and the heir for years to come. There are, however, exceptions that require careful and skilled legal advice. An expert attorney in the area of estate planning should be consulted to determine how best to create such a trust and whether doing so is wise given your unique circumstances.