How a Spendthrift Clause Protects Your Children’s Inheritance

Aug 6

What is a spendthrift clause and why should I make sure to include one in my trust?

A spendthrift clause provides protection against voluntary and involuntary transfers of trust assets. For example, in the event that a beneficiary (e.g., your child) gets divorced, sued, or files for bankruptcy, the spendthrift clause (in conjunction with a properly structured trust) would protect those assets. Not surprisingly, many parents look for this type of protection when creating a trust for the benefit of their children until they feel their children have reached full financial maturity - generally somewhere between age 25 and 35.

Spirit of the law behind the spendthrift clause

The spendthrift clause originated in English common law, but has been further refined over the years in Massachusetts through cases like Broadway National Bank v. Adams, 133 Mass. 170, 173-174, (1882). The concept embodies the principle that the creator of a trust (the “grantor”) ultimately decides when and how money should be used for the benefit of another, and therefore the grantor should be able to place restraints on the use of such funds. In other words, if you give someone (the “trustee”) the discretion on whether or not to provide a beneficiary with money, then that intention should be honored. So long as a beneficiary isn’t entitled to the asset in an absolute legal sense, then the trustee has the ability to redirect or simply hold onto trust assets until the trust says otherwise.

Practical application of the spendthrift clause…

Although the language in the spendthrift clause has a broad application, parents can craft their trust to address specific concerns about their children’s unique circumstances and the type/amount of assets held in trust. For example, some parents are afraid a large inheritance will disincentive action and prevent their children from being a productive member of society (the common thinking being that many of us are first driven to action out of necessity and it is only after we have experienced the joy of being of service to others that we realize true fulfillment comes through having a purpose rather than trying to fill the happiness void with materialism). Other times parents are simply terrified by the thought of a young adult having a pile of cash to be used at their discretion. Coming out of college, most of us really don’t understand the value of a dollar until we have to get a job and provide for ourselves (also known as entering the real world). There are also parents who worry about a child with a gambling or substance abuse issue and realize that such a child can never have the money outright or else risk their personal health and safety - therefore, they may structure their trust to not distribute principal (and thereby be protected by the spendthrift clause) for the entirety of their life.

Fortunately, the spendthrift clause paired with the right language can help you as a parent virtually guarantee that the money you leave for your children is used for their benefit in a responsible manner without the risk of the money being caught up in lawsuits, bankruptcy or divorce. To be clear, the spendthrift clause only works if it restrains both voluntary and involuntary transfers of a beneficial interest. That means if the beneficiary has discretion or entitlement to the trust assets, then the spendthrift clause could lose most or all of its power. For that reason, such a clause does not function well unless there is a clear separation between the trustee and the beneficiary.

Put differently, if a beneficiary is serving as the only trustee and there is no explicit restraint on his or her power to distribute assets to him/herself, then the clause has minimal effectiveness against claims that could arise against that beneficiary. That is why it is common for parents to name an independent trustee (could be a cousin, close friend, sibling, or professional advisor). In addition to having an independent trustee, the spendthrift clause is only good so long as the assets are actually held in trust. For example, many clients will have the trustee withhold distributions in a tiered fashion (e.g., one third to be distributed at 25, one half of the remainder at 30, and all of the remainder at age 35, or something to that effect). This structure allows the beneficiary to have sufficient time to develop financial maturity and life experience between the distributions.

While divorce, bankruptcy, and general financial mismanagement are things that the beneficiary should hopefully outgrow, there is another set of risk that never really goes away - malpractice. Of course, the beneficiary can have insurance in place for something like this if they are a medical doctor, attorney, or in another high-risk occupation, but (once again) for peace of mind, the occupation of your beneficiaries is something to consider when deciding how far you want to go in limiting distributions to your children.

Can I use a spendthrift clause to protect my own assets for my own benefit?

The short answer in Massachusetts is no. There are certain states that do have domestic asset protection trust statutes or case law that may allow some options for such planning, but generally a spendthrift provision is one of those things that is intended to be used for the benefit of another (also referred to as a third-party beneficiary). In most cases, a spendthrift clause is really just an extension of the parent’s control from the grave. In other words, the trust acts as a mechanism of continuity that applies beyond your lifetime.

Can a spendthrift trust or clause be broken?

There are some key exceptions to the validity of a spendthrift clause regardless of how well it is drafted and structured. The biggest ones would be a claim or judgment against a beneficiary for child support or a claim by a State or the Federal government. At the end of the day, public policy will always play a role in the true effectiveness of a trust’s protective powers so you should never assume any clause is a silver bullet to your problems. With that being said, in private transactions it creates a legal barrier that is hard for creditors to breach and there really is no downside of putting such a clause in your trust. Therefore, if you are a concerned parent that wants to make sure the money you leave to your children has an extra layer of protection, then a spendthrift clause should always be included in your trust document.

If you have any other questions about spendthrift clauses or would like to learn more about estate planning in general, then you can reach me at 781 202 6368 or by email at jlento@perennialtrust.com.

Always happy to help.

Sincerely,

Joseph M. Lento, JD

Sources and other helpful reading:

https://www.montefortelaw.com/blog/what-is-a-spendthrift-provision-.cfm

https://sharrylaw.com/using-spendthrift-trusts-in-massachusetts/

https://malegislature.gov/Laws/GeneralLaws/PartII/TitleII/Chapter203E/Article5/Section502

http://www.bovelanga.com/~bovelanga/wp-content/uploads/trustworthyadvisor/Death%20of%20the%20Spendthrift%20Trust.pdf

https://www.oconnelllawgroup.com/will-a-spendthrift-trust-help-protect-my-heirs-from-themselves/

https://www.law.cornell.edu/wex/spendthrift_clause

http://lewislawoftrusts.lawbooks.cali.org/chapter/spendthrift-trusts-and-creditors/

https://elder-law.com/spendthrift-trust-might-not-protect/