As you’re creating an estate plan, it’s likely that you have children or grandchildren you’d like to leave an inheritance to. Maybe you have money you’d like to give them for college or a chunk of cash for their first house. However, it’s possible that your heir is less than financially responsible, and you know that the money might not be used as intended.
If you have concerns about leaving a relative an asset, you can create an asset protection trust—also called a spendthrift trust.
How an Asset Protection Trust Works
A spendthrift trust is a helpful estate planning tool to protect a beneficiary from an inability to use money wisely. This type of trust helps ensure that you provide for a beneficiary but in the way you want and according to your terms.
The Spendthrift Clause
An asset protection trust typically has a spendthrift clause or provision. This provision states that the trust is the sole owner of the assets you want to give to your beneficiary. Thus, when you die, ownership of the assets isn’t transferred to the beneficiary. Instead, the trust “holds” the assets, and a trustee you appoint handles their distribution.
Key Tenets of the Clause
- Your designated beneficiary still receives the assets.
- The assets are released from the trust based on a schedule you create with the trustee.
- A gradual or phased distribution of assets designed to help protect the beneficiary from recklessly wasting money.
- This clause also helps block all creditors from accessing the assets.
Why a Spendthrift Trust Can Be Helpful
Rather than giving your heir a lump sum of money, an incremental distribution helps preserves your intent to provide for their future, especially if the heir:
- Has a history of making poor spending decisions
- Is immature or impulsive with money
- Has an alcohol or a drug addiction
- Could be easily cheated out of the money
- Is involved in a lawsuit
- Is in debt
Benefits of an Asset Protection Trust
Each state determines how trusts are created and handled, as well as the benefits afforded by you, the grantor. Thus, you would establish your spendthrift trust according to the laws of New York. Because this type of trust usually has strict legal rules and requirements, it’s important to work with a skilled estate planning attorney to ensure your trust is in compliance.
Key Benefits of a Spendthrift Trust
- You have asset control. As grantor, you retain control over the assets and can act as the discretionary beneficiary.
- Tax protection. When calculating taxes, this type of trust is treated as a stand-alone trust and not considered during tax time, as the beneficiary’s assets are excluded from the overall estate.
- Divorce protection. If the spendthrift trust is established as an irrevocable trust for your beneficiary, assets are shielded from divorce allocations.
Important Language When Drafting a Spendthrift Trust
A knowledgeable estate planning attorney will draft an asset protection trust any way you like, but it’s important to clearly state that you are, in fact, creating a spendthrift trust. If the correct language isn’t used to identify the trust’s purpose, your heir may be able to remove more money than allowed, or creditors may gain access to the assets.
When you accurately word the clause in your spendthrift trust, you also confirm that the heir has no say in how the funds are distributed, and that they must be removed according to the instructions written in the trust.
Designating a Trustee
As mentioned, when you designate a trustee for an asset protection trust, this individual has a critical role in administering funds to the beneficiary. When you create the terms of the trust, you explain the power of the trustee and how much control they have over the assets. It’s also important to remember that you, the grantor, can be the trustee of the spendthrift trust—but a trustee can’t be a beneficiary.
What a Trustee Can Do
- You may require the trustee to pay the heir a set amount of money every month.
- The trustee may also, with your permission, determine how much money should be given to the heir at any certain time and when.
- You may require the trustee to purchase certain services or goods for the beneficiary instead of allowing them to purchase for themselves.
- There might also be a need for set limits on asset distribution, or a stipulation that allows the trustee to withhold distribution should the beneficiary use the assets improperly.
When writing a trust, it’s important that, as the grantor, you understand the significant position of the trustee and the burden they might feel while carrying out their duties. Even if you name yourself the trustee, you should designate a successor trustee to handle the assets upon death.