The actual definition of a ‘spendthrift’ is: a person who spends (uses) money in an extravagant, irresponsible way. And there are other names for spendthrift - profligate, prodigal, and squanderer.
In England, in former times an errant son (or a younger son who was not expected to inherit) was often sent “across the pond” (to the U.S) to work and seek their fortune. They were given a stipend to remain there, so as not to bring the family estate to financial grief or create problems for the rightful heir.
Nowadays, we have a slightly easier method to protect property from a “spendthrift” heir, or to protect assets from their creditors. There are provisions to a trust (commonly called spendthrift provisions) that can be incorporated into a trust.
Sometimes a family member is facing bankruptcy. In this situation a spendthrift provision can be a useful tool as a means of structuring an inheritance. The trust may protect the inheritance from the family member’s creditors.
The issue then becomes… What qualifies as a “Spendthrift Provision”? This can vary from state to state, but usually a spendthrift provision is part of an irrevocable trust and contains language which makes it non-transferrable by the beneficiary. In other words, the beneficiary has no control over the contents/assets of the trust, (this is an important point of law) and is simply subject to getting whatever benefits the trust allows to him or her. Such provisions prevent the beneficiary from exercising control of the trust assets (another important provision).
Under Colorado law, to qualify as a spendthrift trust, the beneficiary has no control over the assets of the trust. There must be provisions in the trust document that prevent the beneficiary from exercising any control of the trust assets and the beneficiary cannot control the “corpus’ of the trust. In addition, the trust cannot name the creator of the trust as a beneficiary. In other words, you cannot create a spendthrift trust with yourself as beneficiary.
In adherence to Section (§541(c)(2)) of the bankruptcy code a spendthrift trust does not become part of the bankruptcy estate when a beneficiary of such a trust files for bankruptcy. This is an important point, since if an asset is not part of the bankruptcy estate, the asset is not subject to liquidation by the bankruptcy trustee, and is therefore safe from the reach of creditors. But Beware: Although the corpus of the trust is protected, the payments made to the beneficiary of the trust may be subject to bankruptcy proceedings.
Let us take a simplified example:
Grandpa Monroe wants to give an inheritance of $80,000 to his grandson, Spendthrift Larry. Larry is close to filing for bankruptcy. If Grandpa considered giving the $80,000 as an inheritance to Larry (and then Grandpa died), it becomes part of Larry’s assets and therefore subject to liquidation by the bankruptcy trustee. The inheritance of $80,000 from Granpa Monroe could go towards clearing Larry’s debts to his creditors.
Smart Grandpa establishes a spendthrift (provision) trust for Larry. Larry will not be able to touch the principal of the $80,000 (the ‘corpus’ of the trust.) Larry will have no control over the trust or the ‘corpus’ of the funds.
Further, the trust stipulates that Larry will receive a monthly amount of $1,000 from the trust. Thus, the bulk of the inheritance from Grandpa Monroe is protected from Larry’s creditors. However, the $1,000 that Larry received monthly from the trust might be subject to liquidation by the bankruptcy. It could be counted as one of Larry’s assets.
The above is a very simplified example. Spendthrift provisions are often complex legal documents.
A properly structured spendthrift (provision) trust can be a powerful tool in situations of the bankruptcy of a family member. The specialized knowledge of an experienced Wills and Trusts lawyer is needed because there are numerous complex considerations to such a provision as well as unexpected outcomes to an improperly structured trust.
In addition, state statutes change and it is advisable to seek the advice of an attorney in the state where the trust is created.
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