spendthrift provision creates an irrevocable trust preventing creditors from attaching the interest of the beneficiary in the trust before that interest (cash or property) is actually distributed to him or her.

You’re working with your estate planning attorney, creating a will and a trust.  You’re planning to leave a legacy for a particular beneficiary, but you have some concerns about how that person would handle a large inheritance. Might he/she be talked into some risky swampland-in-Florida type of investment, using the expected inheritance as collateral? Including a spendthrift clause in your document can stop that possibility in its tracks.

How does the protection work?  A spendthrift trust is meant to protect assets for heirs who are:

  • Mentally incapacitated
  • Wasteful with money

The spendthrift clause is a provision in a trust that prevents the creditors of any beneficiary from touching the assets so long as those assets remain in the trust.  The beneficiary cannot spend the money before getting a distribution. That restriction remains in effect even in the event that your beneficiary declares bankruptcy.

Your estate planning attorney can help you set up an irrevocable trust naming one or more beneficiaries, and the spendthrift provision is part of the language of that trust. (In Indiana, no one can set up a self-settled spendthrift trust for him or herself.)

Interestingly, as the Indiana Law Journal points out, “It is immaterial whether or not the beneficiary is in fact a spendthrift…. The purpose of the settlor in creating the trust is to protect the beneficiary against his own folly, inefficiency or misfortune.” Of course, once a distribution of assets has been made out of the trust and given to the beneficiary, those assets become available to all creditors.

Can creditors ever reach the assets in a spendthrift trust while the assets are still in the trust? Yes, exceptions to the spendthrift protections usually involve:

  • Child support
  • Alimony
  • Governmental claims (taxes and penalties)

A spendthrift trust is a useful tool, helping to ensure that the assets you’ve worked so hard to build are used in the ways you intend.
– by Rebecca W. Geyer