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What is a Spendthrift Trust?

03.23.12 written by

As the name suggests, a “spendthrift” trust is simply a particular type of trust agreement that is designed to protect a beneficiary from wastefully spending his or her share of the trust. In other words, a spendthrift trust is commonly used when the person funding the trust (called the “grantor,” “donor” or “settlor”) wants to protect a beneficiary from the beneficiary’s own tendency to uncontrollably, imprudently, and usually rapidly, exhaust assets.

Mechanically, spendthrift protection can be incorporated into one’s estate planning in several ways. In certain situations, a complete spendthrift sub-trust is recommended for a particular beneficiary, which is typically a sub-trust of the settlor’s own revocable or irrevocable trust and is funded upon the death of the settlor. Another way to take advantage of spendthrift protection is to make sure that a general spendthrift provision is included as part of a trust agreement. In Ohio, Revised Code §5805.01 validates the use of spendthrift provisions, and while the language of spendthrift provisions can vary, the wording promoted by the promulgators of the Ohio Trust Code is as follows:
“After my death no interest in income or principal shall be voluntarily or involuntarily anticipated, encumbered, assigned or subject to claims of creditors, spouses, former spouses or others.”

One common scenario in which spendthrift trusts are used occurs where wealthy parents know that one or more of their children are not able to handle money well. In that situation, the parent will typically designate a third party, such as a different financially trustworthy family member or a trusted company to serve as trustee of the ne’er-do-well child’s share with specific limitations on the child’s right to access the trust assets, and, more importantly, on the rights of the child’s creditors to reach the child’s share.

However, spendthrift trusts can serve other important roles beyond merely protecting a child from his or her own financially irresponsible propensities. For example, spendthrift planning is prudent in situations where a beneficiary may be quite astute financially but working in a profession prone to litigation, such as medical malpractice. Parents of an adult child who practices medicine who allocate that child’s share to a spendthrift trust, seal those assets from any attempts of judgment creditors to reach them or any attempts by outsiders to attach a lien against the beneficiary’s trust interest.

A spendthrift trust is commonly used when the person who creates and funds the trust wants to protect a particular beneficiary either from the beneficiary’s own tendency to unwisely exhaust assets or to protect a beneficiary who may face claims from outside parties, including as we will see below, from Medicaid.

A growing area in which spendthrift trusts are used is in the context of special needs planning. In this arena, not only is a spendthrift provision like the Ohio version mentioned above important in the trust agreement, but it is also beneficial to structure the sub-trust for a special needs beneficiary as a wholly discretionary trust. By granting the trustee full discretionary power to decide when, how much, and even if any distributions should be made, such a sub-trust is not countable as a resource of the beneficiary when determining eligibility for needs-based benefits such as Medicaid and Supplemental Security Income. Because special needs can cover a wide spectrum of disorders – from developmental disabilities such as Down’s Syndrome and autism, to mental illnesses such as schizophrenia and bipolar disorder, and even encompassing physically disabling conditions such as multiple sclerosis and severe arthritis – the usefulness of protecting a loved one’s eligibility for government-funded medical coverage and financial benefits through the use of a discretionary spendthrift trust is an attractive planning tool.

NOTE: This general summary of the law should not be used to solve individual problems since slight changes in the fact situation may require a material variance in the applicable legal advice.