Leaving money behind for an heir can be nerve-racking, especially if they’re new to managing money or have trouble controlling their spending. A spendthrift trust is an estate planning tool that gives a trustee the power to determine how the beneficiary can use inherited funds. If structured properly, this type of trust can help your assets last for decades, providing for your loved ones. You may also want to consider working with a financial advisor who can build a holistic plan for your estate.
What Is a Spendthrift Trust?
A spendthrift trust restricts the beneficiary’s direct access to its funds. Instead, one or more trustees have the authority to manage distributions, determining how and when the beneficiary receives money to cover their living expenses. So, if the beneficiary is quite young or has shown signs of financial irresponsibility, you can still ensure that they’re taken care of without worrying that they’ll squander it all.
The basics of who’s involved with a spendthrift trust are the same as any other type of trust. Here’s a breakdown of each:
- Trustor or grantor: The original owner of the assets within a trust.
- Beneficiary: The person or people who receive the assets in the spendthrift trust.
- Trustee: This is the individual who’s responsible for making sure that the trustor’s wishes are carried out according to their stated instructions. They also serve as the intermediary between the trust and the beneficiary.
How Does a Spendthrift Trust Work?
One significant advantage of a spendthrift trust is its ability to shield assets from creditors who might otherwise pursue claims against the beneficiary. Because the funds legally remain under the trust’s ownership rather than the beneficiary’s, creditors cannot access them to satisfy debts.
So, let’s say your beneficiary spends money that he or she doesn’t have – for instance, by running up a big credit card bill. While they remain responsible for their debts, your assets will be protected. One thing to keep in mind: You can’t create a spendthrift trust and name yourself the beneficiary just to evade claims against yourself. Most states have laws against this action.
How to Create a Spendthrift Trust
The process of creating a spendthrift trust is nearly identical to establishing any other trust. The main difference between these processes and a spendthrift trust is that you must include a specific spendthrift provision. This is the section in which you describe how the trustee will control the beneficiary’s access to your funds.
For example, you can stipulate in the spendthrift provision that the beneficiary’s access to the trust is restricted annually to a certain amount. Alternatively, you can mark down that your trustee has the authority to decide what this annual restriction will be. Another possible provision might include limiting what your beneficiary can spend the money on. In other words, it’s up to you, for the most part.
States have slightly differing rules about what you can and can’t stipulate in a spendthrift provision. The specific language used can be significant. To ensure you’re following the rules, you may want to consult with an estate planning attorney who’s familiar with the laws in your state.
How to Choose a Trustee for a Spendthrift Trust
Choosing a trustee for a spendthrift trust is important because this person will manage the money and follow the trust’s rules. The trustee is responsible for distributing funds, protecting assets and making sure the beneficiary uses the money as intended.
You can pick a family member, friend, or professional trustee like a bank or trust company. Family members or friends may know the beneficiary’s needs better, but professional trustees offer experience and fairness. However, professional trustees may charge higher fees.
Make sure the trustee is reliable, organized and comfortable handling financial tasks. Talk to them about the role to confirm that they understand the responsibilities and are willing to manage the trust properly.
Who Should Use a Spendthrift Trust?
Anyone who wants to leave significant wealth to a loved one but has concerns about those funds lasting should consider a spendthrift trust. The peace of mind that this type of trust offers is priceless in the right situation.
Let’s say you have a healthy sum of money that you want to use to support a young grandchild. In this situation, a spendthrift trust could be much more useful than something like a savings account. Plus, because your grandchild is young, there’s no telling what kind of money habits they might develop. For these reasons, you may be uncomfortable creating a traditional trust for your assets, making it a perfect opportunity for a spendthrift trust. Take time to choose a trustee with sound judgment, especially regarding financial management.
Pros and Cons of a Spendthrift Trust
A spendthrift trust offers several advantages, but it also comes with potential drawbacks.
One of its primary benefits is asset protection. Beneficiaries are shielded from creditors, lawsuits and divorce settlements since they cannot directly access the funds. It also ensures control over spending, with a trustee managing distributions to prevent beneficiaries from making impulsive or irresponsible financial decisions. The trust’s terms can even be customized by the grantor, allowing for tailored guidelines on when and how funds are distributed to provide long-term financial security.
Spendthrift trusts also protect beneficiaries from external pressures, as they cannot sell or pledge trust assets, reducing the risk of manipulation or poor financial decisions.
However, there are some downsides to consider. Beneficiaries have limited access to their inheritance, which can be frustrating, particularly in cases of financial emergencies. And since they rely entirely on the trustee for distributions, delays or disagreements may arise.
Establishing and maintaining a spendthrift trust can also be expensive due to legal fees and trustee costs. Plus, if the trustee is not carefully chosen, there is a risk of fund mismanagement or self-serving actions that could harm the beneficiary’s financial well-being.
Bottom Line
It’s a natural impulse to want to ease the lives of your loved ones, especially once you’ve left them. A spendthrift trust allows you to do just that, while maintaining some semblance of protection. The last thing you want is for the money you leave behind to vanish within a few years due to reckless spending or creditor claims. Under the right circumstances, a spendthrift trust can provide an optimal combination of protection and freedom.
Tips for Planning Your Estate
- A financial advisor can be a big help in building a financial plan that takes care of you and your family. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Many people choose to supplement their trust with a will. The process of formulating a will might seem daunting. But there are many online will creation services available to walk you through putting this all-important document together.
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