Spendthrift Trusts for Children: Everything You Need To Know
In a straightforward estate plan, parents tend to leave assets to their children outright and in equal shares. An outright distribution requires a trustee to sell or liquidate assets and transfer the proceeds to the beneficiaries, with no strings attached. When the trust estate is distributed, the trust terminates and ceases to exist. Some parents are lucky in that their children can be considered financially responsible adults. Certain beneficiaries can go far with their inheritance – invest in a business venture, buy a home, pay for school. But for that child that can’t be trusted to spend his inheritance wisely, due to gambling, substance abuse or just reckless or immature behavior, a parent would be wise to attach some strings to the inheritance. For parents anxious about their child’s future, a possible solution is the “spendthrift trust”, which is designed to prevent wasteful spending in favor of preserving assets for prudent and necessary expenditures.
How a Spendthrift Trust Works
As with an LLC, corporation, partnership, etc., trusts are separate legal entities created for the purpose of holding assets and often, making distributions to the named beneficiaries. Spendthrift trusts can be created during someone’s life by sitting down with an estate attorney, naming a trustee and beneficiaries, setting down all conditions in writing, and executing the trust instrument. Or, a spendthrift trust can be created via will. Creation during life is recommend for three main reasons: (1) you get to set the trust terms; (2) properly funded trusts avoid the need to probate a will; (3) easy and efficient distribution at death. Taking the time to invest in a spendthrift trust during life saves the estate lots of time and money in the long run, by avoiding court backlog, will contests, executor contests, and attorney billing. Another downside of a will is that once filed with Surrogate’s Court (a necessary step for probate), the document is public information. Creditors, left-out heirs and practically anyone, can view the decedent’s will and the estimated value of his assets, and pass judgment. A trust, on the other hand, is private, only for the viewing of the trustee and the beneficiaries.
Instead of completely disinheriting a child for their wasteful ways, a parent can “rule from the grave” via a spendthrift trust. The trust can direct the trustee to preserve the inheritance over the child’s life or pay out the trust estate when the child reaches a certain age (ie 30 years old), or be a hybrid of the two. At the death of the parents, the spendthrift child’s share continues to be held in trust, perhaps with a trusted relative or a lawyer as trustee or co-trustees. The trust fund can be applied towards the child’s education, housing, health, support, and possibly as seed money for a business. On that child’s death, any assets remaining in the trust estate can pass to that child’s children, a charity or any other beneficiary of the trust creator’s liking.
Another distribution method is to sprinkle the trust estate among the children and grandchildren, in equal or unequal shares. In the trustee’s sole discretion, the income (ie interest, rental income, etc) and principal is allocated among the beneficiaries. The beneficiaries have no power to compel pay-outs from the trustee, yet the trustee is mandated to pay support and necessary expenses of the parties. Besides the preservation of wealth, the sprinkle distribution method has a tendency to protect the trust fund and inheritance from the beneficiary’s spouse.
If parents have no desire to enforce strict control, but still have concerns over the child’s ability to manage money, an alternative approach is installment payments over time. For example, one-third of the trust fund to the child upon him attaining age 25, then one-third of the balance to the child upon him reaching 30, and the remaining balance at age 35. The idea behind this approach is that the child can receive some money, and with time he may grow fiscally responsible before the next pay-out. A great feature of trusts is their flexibility; the creator can impose certain conditions in addition to age before distributions are made.
Selecting a Trustee For Your Spendthrift Trust
When forming a spendthrift trust for children, family dynamics may get in the way of effective trust management. With that said, naming a family member as trustee may not be the best choice for every estate plan. Conflicts between trustee and beneficiary over distributions may get personal and ruin relationships, and worse yet tie up assets in court over hurt feelings and principle. A healthier choice for a trustee might be a faithful friend or a lawyer. Its always good to name a few back-up trustees in the event that the primary trustee is unable to fulfill his duties due to death, incapacity, removal or no want or desire to serve.
Spendthrift Trust in a Nutshell
In sum, a spendthrift trust is a type of trust that limits or altogether prevents a beneficiary from being able to cash-out on his inheritance or assign his trust fund to a creditor. These trusts are commonly used to care for beneficiaries who are incompetent or simply are unable to manage their financial affairs. Today, almost every trust incorporates spendthrift language that says something like this:
The interest of any beneficiary in either the income or principal of the trust fund or any part of it shall not be alienated or in any other manner assigned or transferred by such beneficiary; and such interest shall be exempt from execution, attachment and other legal process which may be instituted by or on behalf of any creditor or assignee of such beneficiary; nor shall any part of such interest be liable for the debts or obligations (including spousal and/or child support, except as required under New York law) of any such beneficiary. This paragraph is intended to impose a “Spendthrift Trust” on all interests held for any beneficiary. IT IS SETTLORS’ INTENT THAT THE PRECEDING SPENDTHRIFT CLAUSE AND THE PROTECTIONS IT PROVIDES BE CONSIDERED A MATERIAL PURPOSE OF THIS TRUST AND ANY SUBSEQUENT TRUST CREATED HEREUNDER.
Kamilla Mishiyeva is an attorney practicing trusts and estates law with Mishiyeva Law, PLLC, 85 Broad Street, New York, New York 10004. Kamilla knows trusts! Our services include domestic (New York) and foreign (off shore) trusts. She can be reached at 646-233-0826 or firstname.lastname@example.org. This article is intended to provide general information, not legal advice.