Asset Protection Using a Spendthrift Trust or Discretionary Trust

For many people, an important part of estate planning is protecting the assets of the estate for the estate’s beneficiaries. If your beneficiaries have creditors, or if they could wind up with creditors down the road, asset protection should be of some concern. Odds are, you probably know someone who has a lot of debt. The average U.S. household carries $129,579 in debt–$15,355 of which sits on credit cards. Not all of that debt is necessarily bad, of course, but sometimes debt can become a crushing financial problem–one the debtor may have a tough time recovering from. Additionally, people without a lot of debt now could wind up with significant debt after a medical problem, a bad result in litigation, or some other unpleasant surprise.

If you plan to give part of your estate to someone with a lot of debt or someone who struggles with money management, giving them part of your estate outright might not be the best solution. Why? Because whatever the beneficiary gets could be attached by a creditor or counted as part of the beneficiary’s assets for settling bankruptcy. In addition to beneficiaries in debt, beneficiaries who have trouble managing money might also be better off not getting estate assets outright.

One way to protect those assets–at least temporarily–is to place a beneficiary’s interest into a “spendthrift trust.” A spendthrift trust prevents the beneficiary from transferring his or her interest in the trust to someone else. This takes the property out of the beneficiary’s control, which keeps it from being attached by most creditors.

“Most” Creditors? Exceptions to the Protection of a Spendthrift Trust

In Missouri, there are a few exceptions to the creditor protection:

  • Debts owed to the government. Both the state and federal governments can get to the beneficiary’s interest in the trust.
  • Child support. Not surprisingly, a child support order can attach to the assets.
  • Spousal support. Similarly, an ex-spouse who has been awarded spousal support or maintenance by the court can get to the assets.
  • Service provider protecting the trust. A service provider who has provided services to protect the beneficiary’s interest in the trust can also get to the assets.

Additionally, the assets aren’t safe forever; once assets are actually distributed to the beneficiary, creditors can come after those assets just like anything else the debtor owns.

Another Option: The Discretionary Trust

In Missouri, a discretionary trust is protected from creditors if the trustee has the discretion to make distributions. If a particular distribution in mandatory according to the terms of the trust, creditors can get to the amount of those distributions.

Somewhat surprisingly, a distribution is not mandatory even if there are standards in place for distribution. Also, the beneficiary may serve as trustee of a discretionary trust without destroying the creditor protection.

There is some risk that without a mandatory distribution in place, the trustee could abuse his or her discretion. In a situation where the trustee may have abused his or her discretion, the beneficiary can sue to compel a distribution. The beneficiary can do so without affecting the creditor protection. Of course, once a distribution is made, those assets are no longer protected, and a creditor can reach those assets just like anything else the beneficiary owns outright.

Either of these methods can help protect beneficiaries with debt or who might accumulate future debt. When you’re putting together an estate plan, this is an issue worth bringing up with your attorney.

Photo credit: Australian Department of Foreign Affairs and Trade, licensed under CC 2.0

Leave a Comment