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Trusts and Asset Protection

Posted: October 27, 2021

In my experience, clients find that one of the most appealing aspects of a trust is its ability to insulate an inheritance against a beneficiary’s creditors. To repel a beneficiary’s creditors, a trust must contain a spendthrift clause. This special clause generally prohibits a beneficiary from transferring his or her interest in the trust to others. Similarly, a spendthrift clause prevents a beneficiary’s creditors from attaching the assets in the trust in satisfaction of a creditor’s claim. Although not an iron-clad shield against all creditors from gaining access to the trust assets, a trust often provides an excellent defense mechanism. A recent podcast by the American College of Trust and Estate Counsel (ACTEC) covered the natural friction between creditor rights and a trust’s ability to shelter assets from a creditor. A few takeaways from the podcast:

  • All 50 states (and D.C.) give effect to a trust’s spendthrift clause, but each jurisdiction has developed its own law in applying and interpreting the clause, and its own exceptions.
  • Many states do not respect a spendthrift clause when a “super-creditor” is involved (for example, a tax authority, a minor dependent, an intentional tort creditor). The scope of a super-creditor, or an exception creditor, will differ from state to state.
  • Even in the absence of a super-creditor, a spendthrift clause is not an absolute bar to a creditor’s ability to reach trust assets. If the trust is a “support trust” and not a fully discretionary trust, a beneficiary is considered to have an enforceable right to compel the trustee to make a distribution, in satisfaction of the trustee’s duty to make distributions for the purposes required under the trust. If the beneficiary has the power to compel a distribution, so too does a creditor of the beneficiary.

Although the spendthrift clause does not create an impenetrable wall against a beneficiary’s creditors, the nuances of the language in the trust instrument, coupled with a state’s laws and the facts and circumstances in any particular circumstance, will determine whether a creditor will be able to gain access to the trust assets. For this reason, it is critical that a qualified estate planner be enlisted to assist with structuring the plan if asset protection is one of the reasons why the client is using a trust.

Moreover, a creditor faced with a debtor trust beneficiary should not be so easily resigned to never reaching the trust assets. In such a circumstance, a creditor would do well to consult with a qualified estate planner to interpret the trust, and whether the trust is really impenetrable.

Podcast: https://actecfoundation.org/podcasts/creditors-rights-vs-trustees-protections/#