What is a Spendthrift Trust, and Do You Need One?

Couple estate planning with attorney in Washington State

You have worked hard to accumulate wealth to better your life and the life of your family. However, you may have noticed that the spending habits of some of your offspring or potential heirs are less than frugal. If you are concerned that someone may immediately deplete an inheritance meant to last a lifetime, a spendthrift trust may be the solution.

A spendthrift trust can protect your heirs from poor financial decisions. Read on for answers to some of the biggest questions regarding spendthrift trusts. We’ll start with the first and most significant one: the spendthrift trust definition.

What is a spendthrift?

There’s no shame in not knowing the definition of spendthrift. The term is not used too often these days. However, it’s tempting to assume a definition. Since spend means to “pay money for goods and services” and thrift means “using money and resources carefully and not wastefully,” it is natural to assume that a spendthrift is someone careful with their money.

Nope. Oxymoronically (and somewhat annoyingly), the definition of spendthrift is “someone who is wasteful with money and spends it freely or foolishly.”

However, that wasn’t always the case. It turns out that the definition of thrift completely changed in the 16th century. The word thrift originated in the 10th century from an Old Norse term meaning “well-being” or “prosperity” (it’s related to the verb thrive). So, until the 1500s, spendthrift made sense as someone who wasted their prosperity. Then in the 16th century, English speakers gradually decided that, instead of “having wealth,” thrift meant saving wealth. This decision turned spendthrift into a confusing mess, which may be why we use the term less now. Unless, of course, we happen to be discussing a spendthrift trust.

What is a spendthrift trust?

A spendthrift trust is a way you can continue to protect your hard-earned assets even after they pass to your beneficiaries.

When a trust is created, everything used to fund the trust is also owned by the trust. Typically, as with a revocable living trust, very little changes for the trust’s owner. While the creator lives and can make decisions, they can transfer vehicles, bank accounts, investments, real estate, and other property to and from the trust. The only difference is that those transactions occur in the name of the trust.

When the trust’s creator passes away, distributions are made to beneficiaries according to the terms of the trust. Once everything passes to beneficiaries, the trust closes. However, if a revocable living trust contains a spendthrift clause (also known as a spendthrift provision), the distribution process changes.

What is spendthrift clause?

A spendthrift clause is a provision that transforms a revocable or irrevocable trust into a spendthrift trust.

Instead of a beneficiary receiving an inheritance all at once and the trust closing, the trust remains in effect and continues to own everything. Assets are released to a beneficiary (or beneficiaries) on a predetermined incremental basis. For example, the trust could distribute any earned dividends every quarter or a fixed amount of money on the beneficiary’s birthday. You can also stipulate how the money is spent, such as for school and school-related costs. That way, if a beneficiary is young and new to managing money or financially irresponsible, you can ensure they’re provided for without worrying they’ll immediately squander everything. A trust spendthrift provision also protects assets held in the trust from a beneficiary’s creditors.

The way it works is the trust’s creator appoints a trustee to oversee the distributions and ensure they occur according to the trust’s provisions. This is the same as every other trust. However, with a spendthrift trust, the trustee’s job is not a one-time occurrence. Instead, the trustee continues to oversee the trust and make allocations according to the terms of the trust.

However, that is the trustee’s only job. When it comes to the spendthrift clause, the trustee must make disbursements that comply with the provisions of the trust. If you would like your trustee to have more discretion regarding how and when funds are distributed, you can create a discretionary trust. With a discretionary trust, the trustee can even withhold funds if they believe the beneficiary violated the trust agreement or gets in trouble with creditors.

What are the benefits of a spendthrift provision in trust documents?

The trust is unbreakable.

When created, a spendthrift trust can either be revocable (meaning the trust can be changed) or irrevocable (meaning the terms of the trust and all assets it holds are untouchable). If the trust is revocable, the person who created it can modify, amend, or cancel it as desired.

However, once the trust’s creator passes away, the spendthrift trust becomes irrevocable. Neither the beneficiary nor the trustee can modify the terms of the trust. The irrevocable nature of the trust is a form of asset protection.

It protects beneficiaries from themselves.

For a potentially unreliable beneficiary, such as one with gambling or addiction issues or someone who is young and has no experience with financial matters, a spendthrift clause included as part of a testamentary trust or sub-trust (as part of a revocable living trust) protects their inheritance from poor spending habits and unfortunate life events like a divorce. Because assets are released incrementally rather than in a lump sum, the beneficiary receives a steady, livable income that is secure for years and even decades.

It guards assets against a beneficiary’s creditors.

Not only does a spendthrift trust protect against a beneficiary’s poor monetary habits, but it also protects their inheritance when those habits lead to creditors banging on their door. Legally, the beneficiary does not own the assets in a spendthrift trust; the trust owns them. So, those assets are not part of the beneficiary’s estate (until they receive a portion of the assets as a distribution).

Additionally, the beneficiary cannot access the money held by the trust or offer it to anyone. Because the beneficiary does not own or control those assets, creditors cannot make a claim against them. Although the beneficiary remains responsible for settling with their creditors, the assets in the trust remain safe from their debts.

It avoids the probate process.

Probate is the legal process of transferring titles and assets out of the name of someone who passed away and into the name of their beneficiaries. In Washington State, assets typically take a year to pass through probate. During probate, the court appoints a personal representative with the authority to manage the estate until it is transferred to the recipients. However, many families also need an attorney to probate an estate. The attorney and other probate fees are often much more expensive than creating a trust to avoid probate.

In addition, the personal representative must go to court and obtain letters testamentary to legally establish them as executor, which sometimes takes weeks. Until receiving the letters testamentary, the personal representative has no authority to transfer money or pay bills. So, probate often delays funds getting to beneficiaries, including minor children.

Also, assets that go through probate become part of the public record. Nosey relatives and other snoopy acquaintances can easily and legally access this information. Assets in a trust do not need to go through probate, which speeds the delivery of inheritances, and the details of the trust remain private.

How do you set up a spendthrift trust?

A spendthrift clause is usually included as part of a testamentary trust or in a sub-trust as part of a revocable living trust. Before establishing a spendthrift trust, you may want to discuss the issue with your trustee to ensure they are willing and able to distribute the assets as required. In addition, states have different rules about what someone can and can’t stipulate as a sub- or testamentary trust spendthrift provision.

To ensure that your spendthrift trust follows the laws of your state, it is highly recommended that you consult with an estate planning attorney in your area.

If you have more questions regarding spendthrift trusts or want to start an estate plan, please reach out to Harbor Law Firm.

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