Are you concerned that some of your beneficiaries might squander their inheritances or simply aren’t equipped to handle the financial responsibilities that come with large sums of money? You don’t have to hold onto your assets until the day you die with the hope that your heirs will change their ways by that time. Instead, consider using a spendthrift trust that can provide protection, regardless of how long you live.
As with other trusts, a spendthrift trust may incorporate various tax benefits, but that’s not its primary focus. Regardless of whether estate tax reform is enacted in the near future, this trust type can help you provide for an heir while protecting assets from his or her potentially imprudent actions.
Spendthrift trust in action
With assistance from an estate planning advisor or attorney, set up the trust according to state laws and transfer assets to the trust account. Generally, the assets will consist of securities such as stocks, bonds and mutual funds, and possibly real estate and cash. The appointed trustee then manages the assets.
Essentially, the terms of the trust restrict the beneficiary’s ability to access funds in the account. Therefore, the beneficiary can’t invade the trust to indulge in a wild spending spree or sink money into a foolhardy business venture. Similarly, the trust assets can’t be reached by any of the beneficiary’s creditors.
Instead of having direct access to funds, the beneficiary usually receives payments from the trust on a regular basis or “as needed” based on the determination of the trustee. For example, the trust might call for two scheduled payments to be made during the year for the fall and spring semesters at the beneficiary’s college. The trustee is guided by the terms of the trust and must adhere to fiduciary standards.
Be aware that the protection isn’t absolute. Once the beneficiary receives a cash payment, he or she has full control over that amount. The money can be spent without restriction and may be attached by creditors.
Role of the trustee
The role of the trustee obviously is an important one. Depending on the trust terms, he or she may be responsible for making scheduled payments or have wide discretion as to whether funds should be paid, and how much and when.
For instance, the trust may empower the trustee to make set payments or retain discretion over amounts to be paid or even over whether there should be any payment at all. Or maybe the trustee is directed to pay a specified percentage of the trust assets, so the payouts fluctuate depending on investment performance. In the same vein, the trustee may be authorized to withhold payment upon the happening of specific events (such as if the beneficiary exceeds a debt threshold or has to declare bankruptcy).
Designating the trustee is an important consideration, especially in situations where he or she will have broad control. Although it’s not illegal to name yourself as trustee, this is generally not recommended. More often than not, the trustee will be an attorney, financial planner or investment advisor, or someone else with the requisite experience and financial acumen. You should also name a successor trustee in the event the designated trustee dies before the end of the term or otherwise becomes incapable of handling these duties.
Other key considerations
There are several other critical aspects relating to crafting a spendthrift trust. For example, you must establish how and when the trust should terminate. The trust could be set up for a term of years or termination may occur upon a specific event (such as a child reaching the age of majority). In addition, you should provide for contingencies, such as the beneficiary dying or sustaining a serious illness or injury before the trust ends.
Finally, try to anticipate other possibilities, such as enactment of tax law changes, that could affect a spendthrift trust. A word to the wise: This isn’t a do-it-yourself proposition. Consult your estate planning advisor for assistance when setting up a spendthrift trust.
