Spendthrift clause

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Spendthrift clause
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Spendthrift clause "is a simple and valuable feature included in almost every trust. It has long been used in every state to do two things (M.T. Palermo 2005, s. 220):

  1. The spendthrift clause prevents a beneficiary who goes on a drinking or spending binge, for example, from selling the right to his future trust payments to a loan company for a lump sum of cash.
  2. It takes the trust "off the table" for creditors in the (unfortunate but likely) event the beneficiary is sued as a result of his financial or another irresponsibility".

The spendthrift clause prevents the third party (creditor) from receiving directly what the recipient was to obtain from the trust. However, after making a payment to the beneficiary, it is no longer subject to the clause - it is now the beneficiary's money, and hence, third parties (creditors) can reach for it (M.T. Palermo 2005, s. 221).

How a spendthrift clause works

To illustrate the way in which spendthrift clause works, Michael Palermo cites the following example (M.T. Palermo 2005, s. 220):

"A thirty-five-year-old man driving while drunk killed a mother of two. He was prosecuted for manslaughter, but the victim's family desperately needed compensation for the loss of her income. Although the defendant had the minimum liability insurance allowed by law, it was common knowledge that he had recently inherited a lot of money. The family sued for wrongful death. The jury decided in favor of the family, awarding it almost $1.5 million in damages. Unfortunately for the family, the defendant's inheritance actually took the form of quarterly trust payments of $25,000 from his late father's trust, made at the discretion of a bank trustee. Legally, the trust principal was not the defendant/beneficiary's property; therefore, it was not available to pay the victim's judgment. Courts around the country have ruled along similar lines for many years. Topping it off, the trustee suspended payments to the beneficiary in anticipation of the several years he will spend behind bars. Even in heartbreaking situations like this, the courts virtually always honor spendthrift provisions".

Spendthrift trust

Spendthrift trust is a trust containing a provision that protects the tangible assets of the trust against the creditors and reckless expenditure of the beneficiary. With such a trust clause, creditors cannot take over the principal and interest on that amount until they have been received by the beneficiary and the beneficiary cannot assign the principal and interest before they are received. Without such a provision, the beneficiary entrusted with the money could take the fiduciary instrument to the bank, take out a loan and transfer the rights to the money to the bank as collateral for the loan (G. Brown, S. Myers 2009, s. 239).

Within the spendthrift trust concept, two types of transfers are distinguished (P.T. Wendel 2018, s. 281):

  1. Voluntary transfers - a spendthrift clause need not limit either the beneficiary's voluntary or involuntary transfers. There are savings clauses that block only voluntary transfers made by the beneficiary, but leave open involuntary transfers, thus enabling the beneficiary's third parties (creditors) to reach the property;
  2. Involuntary transfers - a spendthrift clause that only excludes transfers made by the beneficiary which are not in accordance with his will, are considered to be contrary to public policy and are invalid. If a beneficiary has the right to voluntarily transfer his interest, he must also bear the risk that his creditors will be entitled to claim interest on him.

Examples of Spendthrift clause

  1. * A spendthrift clause in a trust allows the trust's beneficiaries to receive distributions from the trust without the risk of creditors being able to attach those distributions.
  2. * A spendthrift clause can also be used to prevent the beneficiary from voluntarily transferring his or her interest in the trust. This means that the beneficiary cannot sell his or her interest in the trust, nor can he or she use the interest as collateral for a loan.
  3. * A spendthrift clause can also be used to create a trust that is only accessible to a certain class of persons, such as only to the descendants of the original settlor.
  4. * A spendthrift clause may also be used to prevent the beneficiary from being able to assign his or her interest in the trust to another person or entity. This prevents the beneficiary from transferring his or her interest in the trust to someone else, either for consideration or as a gift.
  5. * A spendthrift clause can also be used to provide for contingent beneficiaries, such as if the initial beneficiary passes away or becomes incapacitated. This ensures that the trust remains in effect even if the initial beneficiary is unable or unwilling to receive distributions from the trust.

Advantages of Spendthrift clause

A spendthrift clause is an important part of almost every trust, and has been used in every state for many years. Its main purpose is to protect the trust's assets from creditors and to provide security to the beneficiaries. Below are some of the benefits of including a spendthrift clause in a trust:

  • It protects trust assets from creditors, even if the beneficiary has incurred a debt. Creditors are not allowed to access the trust funds, and the beneficiary's creditors cannot claim the trust's assets to satisfy their debts.
  • It allows the trust assets to be used for the benefit of the beneficiaries, as designated by the terms of the trust. The beneficiaries are protected from spending the trust funds on their own debts or other non-beneficial activities.
  • It provides greater security to the beneficiaries, as they can rely on the trust funds to be available to them without fear of creditors taking them away.
  • It allows the trust to be managed more effectively, as the trustees have greater control over the trust's assets and can ensure that they are used in accordance with the trust's terms.

Limitations of Spendthrift clause

A spendthrift clause is a useful tool included in many trusts to protect the beneficiary's assets from creditors. However, there are a few limitations to this clause that should be considered. These limitations include:

  • The clause may not be effective against tax liens, child support claims, or other claims of the federal government.
  • A beneficiary may not be able to make voluntary transfers of trust assets to other parties.
  • A beneficiary may not be able to use trust assets as collateral for a loan.
  • The clause may not be as effective in some states as it is in others.
  • It may not protect assets from a beneficiary's bankruptcy.
  • The clause may be difficult to enforce if challenged in court.

Other approaches related to Spendthrift clause

A Spendthrift clause is an important feature of almost every trust that has two primary functions. There are also other approaches related to Spendthrift clauses that can be used to protect the trust's assets and beneficiaries. These include:

  • Appointing a Trust Protector – A trust protector is a person appointed to oversee the trust and make sure that it is managed and administered in accordance with its terms. The trust protector has the power to modify the trust documents, appoint new trustees, and remove trustees who are not following the trust's terms or are not acting in the best interest of the beneficiaries.
  • Using a Spendthrift Trust – A Spendthrift Trust is a trust that limits the beneficiary’s access to the trust assets. The terms of the trust can specify that the assets can only be used for specific purposes and can also prevent creditors from seizing the trust assets.
  • Setting up a Spendthrift Provision – A Spendthrift Provision is a clause in the trust document that prohibits the beneficiary from transferring or assigning their interest in the trust. This prevents creditors from seizing the trust assets.

In summary, Spendthrift clauses are an important feature of most trusts and other approaches, such as appointing a Trust Protector, setting up a Spendthrift Trust, and including a Spendthrift Provision, can be used to protect the trust's assets and beneficiaries.

References

Author: Patrycja Czerwiec

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