A properly designed trust helps safeguard assets against claims by a beneficiary’s creditors as well as the beneficiary’s own mismanagement. Generally, the less control a beneficiary has over trust assets, the more protection the trust offers against creditors.
To that end, it’s advisable to appoint an independent, professional trustee. But in some cases, it’s desirable to name the trust’s primary beneficiary as trustee. To maximize creditor protection when you name a beneficiary as trustee, consider these strategies:
Add a spendthrift clause. This prohibits beneficiaries from selling or assigning their interests, either voluntarily or involuntarily. Thus, it can prevent a creditor from reaching a beneficiary’s trust interest before the beneficiary receives it. (In most states, there are exceptions for certain creditors, including a child, spouse or former spouse with a claim for support or maintenance and certain government creditors.)
Use ascertainable standards. Discretionary trusts — as opposed to trusts that call for mandatory distributions at specified times or for a beneficiary’s support — generally offer the strongest creditor protection. If distributions are within the trustee’s sole discretion, the beneficiary can’t compel a distribution and, therefore, in theory, neither can a creditor.
Bear in mind, however, that these strategies won’t work in all states, because the laws regarding creditor protection are complex and vary significantly from state to state. If you’re in a state that permits creditors to reach assets available to a beneficiary-trustee, consider naming a co-trustee and at least one other beneficiary. Many states offer creditor protection if a trust includes a spendthrift clause and the beneficiary-trustee holds discretionary distribution power jointly with a co-trustee who owes a fiduciary duty to other trust beneficiaries.
To ensure that your trust is structured and drafted to maximize creditor protection, please contact us.