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An arrangement whereby one person sets aside property for the benefit of another in which, either because of a direction of the settlor (one who creates a trust) or because of statute, the beneficiary (one who profits from the act of another) is unable to transfer his or her right to future payments of income or capital, and his or her creditors are unable to subject the beneficiary's interest to the payment of his or her debts.
Spendthrift trusts are usually established with the object of providing a fund for the maintenance of another person, known as the spendthrift, while also protecting the trust against the beneficiary's imprudence, extravagance, and inability to manage financial affairs. For example, a settlor establishes a spendthrift trust for his son, a compulsive gambler, who spends money injudiciously with no concern for the future. Under the terms of the $400,000 trust, which is to be administered by the family's lawyer, the son is to receive $15,000 a year. Any words that indicate the settlor's intention to impose a direct restraint on the transferability of the beneficiary's interest can be used to create a spendthrift trust.
Such trusts do not limit the rights of the spendthrift's creditors to the property after it is received by the beneficiary from the trustee (one appointed or required by law to execute a trust). The creditors cannot compel the trustee to pay them directly. This means that any of the spendthrift's creditors can seek to have the money the spendthrift has already received applied to satisfy their claims. A creditor's claims to future payments under the trust, however, are restrained. The spendthrift's creditors cannot reach the $15,000 that he is to be paid in a subsequent year until it is actually paid out to him. If such a person could dispose of his right to receive income from the trust, his incompetence or carelessness might lead him to anticipate his income and transfer to monetary lenders and creditors the right to receive future income as it became due. By restricting the spendthrift so that he can do nothing with the income until it is paid into his hands by the trustee, he is more likely to be protected, at least to some extent, against impoverishment.
A spendthrift trust can continue for the life of the beneficiary or be limited to a period of years.
A settlor cannot create a spendthrift trust for herself. If the settlor attempts to do so, the trust is valid but the spendthrift clause is legally ineffective as to the present and future creditors of the property owner. To allow otherwise would be to provide unscrupulous people with the opportunity to shelter their property before engaging in speculative business enterprises and to mislead creditors into believing that the settlor still owned the property because she appeared to be receiving its income, thereby fraudulently deceiving creditors who might rely on the former financial property of the debtor.
In some states, under the doctrine of "surplus income," creditors can reach any trust income that exceeds what is necessary to support and educate the beneficiary. The court hears evidence as to the amount necessary to support the beneficiary in the manner to which he has been accustomed. Any excess of trust income over the sum will be awarded to the creditor and paid directly to her by the trustee. A few states have enacted statutes fixing the percentage of trust income that is exempt from creditor's claims that have been legally determined in a court action.
Certain classes are permitted to reach the beneficiary's interest in a spendthrift trust on the ground of public policy in many states. These include persons whom the beneficiary is legally bound to support, such as a spouse and children; persons who render necessary personal services to the beneficiary, such as a physician; and persons whose services preserve the beneficiary's interest in the trust. Tort claims against the beneficiary as well as claims by a state or the United States, such as for income tax, are not subject to spendthrift provisions.
In some states, when a beneficiary and spouse are divorced and the spouse has been awarded alimony, the trustee of the trust cannot be compelled to pay the full amount of alimony until the court that has jurisdiction over the administration of the trust deems it to be fair.
The majority of states authorize spendthrift trusts; those that do not will void such provisions so that the beneficiary can transfer his or her rights and the creditors can attach the right to future income.
Bove, Alexander A., Jr., et al. 2003. Asset Protection Trusts: Onshore and Offshore. Boston: Massachusetts Continuing Legal Education.
Eason, Jason K. 2002. "Developing the Asset Protection Dynamic: A Legacy of Federal Concern." Hofstra Law Review 31 (fall).
Fox, Charles D., IV, and Michael J. Huft. 2002. "Asset Protection and Dynasty Trusts." Real Property, Probate and Trust Journal 37 (summer).
Nichols, Bryan. 2003. "'I See the Sword of Damocles Is Hanging Above Your Head!' Domestic Venue Asset Protection Trusts, Credit Due Judgments, and Conflict of Law Disputes." Review of Litigation 22 (spring).