Why A Spendthrift Clause could Protect Your Beneficiaries

Just like every meaningful idea that came into existence, the Spendthrift Clause was birthed by the need to protect beneficiaries from themselves and others. What do we mean by that? Well, as a Grantor/Settlor, you reserve the right to provide an inheritance and a gift to anyone you choose.  After all, it’s your money, your assets and your hard work that accumulated whatever it is that you have.  However, it is imperative that as part of the consideration of what to leave to whom, you should also consider who needs help in maintaining and properly utilizing what you leave to them, especially if you are aware that the individual needs help in managing their financial matters or could run into complications or issues in the future.  Sometimes, the signs are not as clear and, in that case, using a Spendthrift Clause can be a powerful tool to provide protection to your loved one, regardless of their known propensities or indiscretions.

What is a Spendthrift Trust/Clause and how does it Work?

A Spendthrift Trust or Clause is a legal document or a clause in a Trust document that provides protections for the property/money or assets that you owned but are transferring to someone else (beneficiary).  The purpose of the “Spendthrift Trust” is to allow someone/something else besides the beneficiary to own and manage the Trust and the assets included in the Trust on behalf of the Trust Beneficiary. The other individual who manages the Trust is called the Trustee.  The Trustee will have a fiduciary duty to manage the Trust assets as instructed by the Grantor/Settlor, but always has the responsibility to act in the best interest of the Beneficiary. The ultimate benefits for Grantors are that they can create specific instructions for the Trustee to follow and can take advantage of the great flexibility available in creating protective parameters for their Beneficiaries.

Another benefit of the Spendthrift Trust is that the Beneficiary does not own the assets in the Trust, therefore, cannot determine or dictate how or when it is used. The Beneficiary cannot access the money, and neither can the Beneficiary’s creditors. Any judgment rendered against the Beneficiary, be it from creditors or from a divorce, cannot attach or access any of the assets in the Trust as payment to them concerning any of the Beneficiary’s affairs. Thus, it is a measure to help curb Beneficiaries and provide protection for the Trusts and assets of the Beneficiary.

The provisions attached to a spendthrift trust clause.

Many states permit the Spendthrift Trust Clause, including  Maryland which codified it in Section 14.5-504 of the Estates and Trusts Article of the Annotated Code  The act states that the  “Spendthrift clause is legal and enforceable, preventing “voluntary and involuntary transfer of the interest of the beneficiary,” banning “judicial foreclosure or attachment” by the creditor and making an attempt by the beneficiary to transfer interest in the trust in violation of a valid spendthrift provision.”

What does this mean?

A Trust placed under a Spendthrift Clause would be protected or refrained from attachment, bankruptcy or any legal proceedings, the interference or control of creditors, or any voluntary or involuntarily transfer of assets. Furthermore, a Beneficiary of this Trust may by no means delegate, expect, alienate, or otherwise voluntarily transfer the income or principal of any Trust generated under that Trust.

For instance, a Spendthrift Clause in life insurance may protect the life insurance proceeds from creditors. In like manner, the Beneficiary’s creditors are forbidden from seeking any benefits until the beneficiary is paid from the Trust. The Spendthrift Clause, asides from protecting a Beneficiary from his or her own financial improvidence, ensures that a creditor may not compel a settlement to pay a debt from a life insurance policy.  As such, it is of greater essence that an insurer can control and hold back funds from creditors under a Spendthrift Clause in life insurance.

Does a Spendthrift Clause provision protect against all claims?

Section 14.5-504 of the Estates and Trusts Article under the Spendthrift provision further deters the transfer of residential real property and tangible personal property by a Beneficiary as well as any interference of creditors. However, it is important to note that Spendthrift provisions do not protect against all creditors or all claims. According to Section 14.5-505 of the Estates and Trusts Article, there are three cases or scenarios that prove this point. The following describes the scenarios.

The first exception that allows a claim against a Spendthrift Trust and Clause is where a  child, spouse, or former partner of the Spendthrift Trust Beneficiary has a court order issuing maintenance or support from the Beneficiary. The second allowable claim against a Spendthrift provision, is where  a judgment creditor provided services for the protection of the interest of the Beneficiary named in the Spendthrift Trust. Lastly allowable, with certain limitations, is a claim of this State or the United States to the extent a statute of this State or federal law so provides.

As such, it is important to have the Spendthrift Clause carefully worded to have enough protection against claims and for overall protection. Although no mandatory word or language is statutorily required in a spendthrift clause, section 14.5-504 of the Estates and Trusts Article however upheld the standard- stating that Spendthrift protection applies where there is “[a] provision of a trust providing that the interest of a beneficiary is held subject to a “Spendthrift Trust.”

Another advisable drafting key provision in Spendthrift Trust to help protect against claims and ill-advised actions is the use of an independent Trustee.  The independent Trustee plays a major role and should be assigned to the Trust when creating it. This secondary Trustee provides an extra layer of protection against creditors or claims against the Spendthrift Clause while also overseeing effective distribution of the Trust.  This key or strategy would be beneficial when a Trust Beneficiary, who was also assigned the role of a Trustee, selfishly and inappropriately distributes the Trust to himself whenever he wants without interference.  Once that extra layer of protection is present, that would deter the Trust Beneficiary from doing so or being able to do so. However, once those assets or funds are given to the Trust Beneficiary, then and only then can the Beneficiary do what he/she wants to do and then and only then would creditors and claims be able to access the assets or funds.

Spendthrift provision in a Self-Settled Trust

While other types of Trusts allow the Beneficiary of the same Trust to be a Grantor or a Settlor, the Spendthrift provisions typically disallows that in a Self-Settled Trust. Subsequently, this becomes an exception for creating a Spendthrift Trust. Maryland, which solidified the Spendthrift Clause over many years, does not in any way recognize protection of a Spendthrift provision in a Self-Settled Trust. Since a Spendthrift Clause is created for the protection of a Beneficiary (or a spendthrift), it would in no way allow an individual to effectively create a Spendthrift Trust for his or her own benefit.

Bottom line

The Spendthrift Clause prevents a Trust Beneficiary from changing the ways in which the Trust funds or assets are designated for payout. Thus, allowing the Grantor to  decide what and when certain parts of a Trust or life insurance policy be given or paid to a Beneficiary.  Don’t pass up on the opportunity to use this strategic tool to help your loved ones. 

With a Spendthrift Clause, you no longer have to worry about how your assets are distributed. What a relief!!

For more information, contact The Lundy Law Group, LLC at [email protected] or call us at 410-480-7090.