Self-settled Spendthrift Trusts

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 What Is A Spendthrift Trust?

A trust is a legal instrument used in estate planning to avoid probate, while also providing a benefit for a specific beneficiary or group of beneficiaries. This legal document allows the owner of property to transfer that property, or have the property managed on behalf of someone else, who is known as the trustee.

Trust laws vary from state to state. Generally speaking, trusts are an efficient way to transfer assets in a manner that can be controlled and managed by the owner. An example would be placing specific conditions on the trust property, which must be met before the property is transferred to the beneficiary.

Creating a trust generally requires:

  1. A trust settlor, or creator;
  2. The settlor delivering legal title to the property;
  3. The property is delivered to a trustee;
  4. The trustee holds legal title to the property;
  5. The legal title is to be held for the benefit of one or more trust beneficiaries;
  6. The intent to create a trust;
  7. The intent to create a trust must be for a lawful purpose; and
  8. The document embodying the trust must be validly executed.

A spendthrift trust is a specific type of trust overseen by a trustee such as a bank or a private lender. The trustee controls how the assets are to be distributed to the beneficiary. This beneficiary is generally not allowed to spend the money in the trust before actually receiving distributions from the trust fund, and they may be referred to as the “spendthrift.”

Parents may create a spendthrift trust for their younger child when they are concerned about how their acquired assets will be distributed or managed. A spendthrift trust may be a practical option for people who have accumulated a fair amount of assets and would like to pass those assets on to their heirs, such as children or grandchildren.

Simply put, a spendthrift trust is a type of trust created to provide for another person’s needs while simultaneously preventing that beneficiary from accessing the trust property. They are generally designed for younger beneficiaries, such as a minor child of the trust’s creator. Under most spendthrift arrangements, the beneficiary will not be able to access the funds until a specific amount of time, generally their eighteenth birthday. However, the accessible date for the funds may also be up to the trustee’s discretion. This should be clarified in the trust document.

What Is A Self-Settled Spendthrift Trust?

A clause contained within the trust will need to explicitly designate the trust as being a spendthrift trust. When there is no spendthrift clause, the courts will not treat it as such. This becomes especially important if any issues arise under the enforcement of the trust.

A spendthrift trust is considered to be “self-settled” when the trust creator and beneficiary are the same person. What this means is that there can be no other beneficiaries of the trust. However, a trustee is still involved, who manages and distributes the funds. Other names for self-settled spendthrift trusts include self-designated trusts or Alaska trusts.

Self-settled spendthrift trusts gained popularity because creditors are restricted from what they can collect under a common spendthrift trust. Creditors cannot take money from the general funds of a spendthrift trust, meaning they can only collect from the distributed funds. This resulted in a surge of people creating self-settled spendthrift trusts to avoid creditors seeking to collect on their debts.

In response, self-settled spendthrift trusts became highly regulated. An example of this would be how most states no longer allow these types of trusts. Many states have laws that have determined that if the trust creator and beneficiary are the same person, they will not be protected from creditors as spendthrift trust funds generally are.

However, some states allow them because they can help protect personal assets. Self-settled spendthrift trusts can also make estate planning easier to navigate and more accessible.

Which States Allow Self-Settled Spendthrift Trusts?

Alaska was the first state to allow self-settled spendthrift trusts, which is why they are sometimes referred to as Alaska trusts. According to Alaska law, there is a four-year period after the trust is created before the trust funds receive protection from creditors.

Nevada also allows self-settled spendthrift trusts. According to Nevada law, there is only a two-year period after the trust is created before the trust funds receive protection from creditors. Additionally, Nevada law allows the person who created the trust to be both the beneficiary and trustee. When this is the case, more restrictions are placed on how the funds can be disbursed.

Several other states besides these two also have laws addressing “Domestic Asset Protection Trusts,” or DAPT statutes. This allows for self-settled spendthrift trusts with the goal of creditors being unable to access the money in the trust. This must be created domestically, as an offshore international account would not qualify.

Under a DAPT statute, the trustee has discretion over distributions. Additionally, the beneficiary’s interest cannot be assigned. These measures are meant to protect the person’s assets, but abuse of this function is still prohibited.

In addition to Nevada and Alaska, the following states have DAPT statutes:

  • Delaware;
  • Hawaii;
  • Michigan;
  • Mississippi;
  • Missouri;
  • New Hampshire;
  • Ohio;
  • Oklahoma;
  • Rhode Island;
  • South Dakota;
  • Tennessee;
  • Utah;
  • Virginia;
  • West Virginia; and
  • Wyoming.

What Are Some Common Legal Issues Associated With Spendthrift Trusts In General?

Spendthrift trusts are created much the same as most other general trusts. The defining difference would be the inclusion of a spendthrift clause, which must show clearly that the trust’s creator intends the trust to be a spendthrift trust. Unless the trust documents include such a clause, courts may not legally consider the trust a spendthrift trust, as previously mentioned.

This can result in a dispute over whether the trust in question is a spendthrift trust or some other type of trust. However, simply using the term “spendthrift” in the clause is generally considered sufficient under most state laws.

Another common dispute occurs when the beneficiary wishes to assert their right to collect a distribution before the time they would be allowed to do so. Courts will generally abide by what is written in the trust with few exceptions. Additionally, disputes may arise when the trustee fails to perform their duties, which could result in the replacement of the trustee with another. This would be decided by either the testator or the court.

Disputes amongst trust beneficiaries are common. An example of this would be if one beneficiary feels entitled to a certain asset or distribution as opposed to another. Court intervention may be required to determine how the trust should be distributed.

Do I Need A Lawyer To Create A Self-Settled Spendthrift Trust?

If your state has a DAPT statute that allows for self-settled spendthrift trusts, contact a local trust lawyer in your area to help you create the trust.

Your trust attorney can determine whether a self-settled spendthrift trust is allowed in your state, and what your legal rights and options are according to your state’s specific laws. Additionally, an attorney will also be able to represent you in court, as needed, should any legal issues arise.

Lastly, trust laws may be subject to change, but your attorney can keep you advised of any updates that might affect your rights.

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