Spendthrift Trust


What is a spendthrift trust?

Image of young shopaholic with her hands full of brightly colored shopping bagsA spendthrift trust is a trust that is created for the benefit of a person who is often unable to control his or her spending and gives an independent trustee full authority to make decisions as to how the trust funds may be spent for the benefit of the beneficiary. Spendthrift trust are often established when the beneficiary is too young, immature, or doesn’t have the mental capacity to manage their own money and wants to protect a beneficiary from the beneficiary’s own tendency to uncontrollably, imprudently —and usually rapidly— will exhaust assets.

Spendthrift trust – a simple example

This is best illustrated by a simple example. Mom & Dad set up a living trust for their children and put $500,000 principal into it to be held for the benefit of the children. Suppose one or more of the children has financial trouble and owes money to creditors. With a properly written spendthrift clause in the trust document, the creditors of the children cannot enforce their claims against the children’s share of the trust. The trustee of the trust still would be have discretion to pay money out to the children. People also can set up trusts to benefit themselves but those types of trust are subject to more limits on the spendthrift provisions.

General rule-transfers to creditors can be prohibited

California law generally allows a trust instrument to legally provide that a trust beneficiary’s interest in trust may not be transferred and may not be subject to enforcement of a creditor’s money judgment. Thus, in the $500,000 put into the trust in the above example, if the money is to be held in the trust until the children reach age 35, then before the children reach that age a creditor with a money judgment against the children cannot reach that money. However when a child reaches age 35 in the example and is entitled to his trust principal distribution, the child’s creditors can get a court order to have the child’s principal paid to the creditors to satisfy the judgment. Likewise, if the trust provides for discretionary payment of trust income to trust beneficiaries (as opposed to mandatory payment of income) then the children’s creditors cannot force the trust to pay the income to them.

Limits if money is owed by the creators (trustors) of the trust

California law does not allow people to transfer their money into a trust (the “trustors” are the people transferring the money into the trust) instead of paying their creditors. The creditors do have some rights and can sue the trust to compel payment to them. Thus, if the trust is set up to have the trustee make discretionary payment to the trustors for their support or education then the creditors of the trustors may compel the trust to pay our the maximum amount that could otherwise have been paid to the trustors. This would be done by a legal proceeding. Also, in some instances, money or property transferred into a trust when the trustors have unpaid creditors can be set aside as fraudulent conveyances and the spendthrift clause does not prevent the creditors from reaching the money or property.

Exceptions for child or spousal support judgments

A spendthrift trust clause cannot be used to prevent the payment of lawfully ordered child or spousal support. Thus, if a trust beneficiary has a right to trust income or principal and tries to evade paying child or spousal support by simply not taking the money, a court can compel the support be paid by the trust. In addition, if the trust is set up for discretionary payments of income or principal, a court can order the trust to make the support payments if the court determines that “it is equitable and reasonable under the circumstances of the particular case”. Thus, the parents setting up a trust for their children, cannot prevent the trust from paying spousal or child support that their children may owe.

Exceptions for felony restitution and public support

As with child and spousal support, California law does allow the creditors of a beneficiary and the state to reach trust assets that would otherwise belong to the trust beneficiary.

Some restrictions on creditors

In some instances, the law will split payments out of the trust to the beneficiary and a beneficiary’s creditor. General creditors are generally limited to a maximum of 25% of any payment and the beneficiary then gets 75%. If the money owing is for support, then the 25% rule doesn’t apply. There are legal rules for proration of payments among creditors.

CALL  (949) 851-1771  to speak with Lawyer  David L. Crockett

Planning is key

When preparing a trust, the possibility of children or trust beneficiaries having financial problems must be considered. Different payment provisions for different children can be spelled out so that the children with financial problems or potential financial problems can have their trust shares held back and not paid out as quickly. The law does not require the all children or trust beneficiaries be treated the same as far as distributions. That is the beauty of a custom drafted trust as opposed to a boilerplate trust or a probate estate with no trust. If there is no trust and the assets are then probated the creditors of the children can capture what the children would otherwise have received from the probate estate.