Given the numerous and varied estate planning goals that a trust can help you achieve, there is a very good chance you will include at least one trust in your plan. The popularity of trusts also means there is an equally good chance that you will find yourself as a beneficiary of a trust at some point. Whether you create the trust or you benefit from the trust, you may find a spendthrift clause in the trust agreement. To ensure that you understand what that means, the attorneys at Augulis Law Firm explain how a spendthrift clause in a trust works.
Trust Agreement Basics
At its most basic, trust is a relationship whereby property is held by one party for the benefit of another. The terms and provisions of a trust are reduced to writing in a document referred to as a “trust agreement.” Trusts are broadly divided into living trusts and testamentary trusts with the former activating during the lifetime of the Settlor (the creator of the trust) and the latter typically being activated at the time of the Settlor’s death by a provision in the Settlor’s Will. Living trusts can be further sub-divided into revocable and irrevocable living trusts while a testamentary trust is always revocable because a Will is always revocable.
What Is a Spendthrift Clause?
One of the many benefits of using a trust instead of a Will to distribute an inheritance is the ability to retain a certain amount of control over how that inheritance is used. A spendthrift clause, or a spendthrift trust, refers to a clause within a trust or a trust agreement in general that is aimed at preventing the beneficiaries of the trust from squandering their inheritance.
Very specific language must be used to create a spendthrift clause; however, when drafted properly, a spendthrift clause will prevent a beneficiary from spending the trust funds frivolously as well as prevent borrowing against those funds or encumbering the funds in any way. A spendthrift clause can also prevent creditors of the beneficiary from accessing the trust funds to pay debts of the beneficiary.
Because the Settlor of a trust has wide latitude when creating the trust terms, a Settlor can use those terms to limit how a beneficiary may use trust funds and may direct the Trustee to make distributions directly to a landlord, school, physician instead of to the actual beneficiary. This is another way a Settlor can protect against the possibility of a beneficiary squandering trust assets.
State laws govern most aspects of trust agreements, including the validity of a spendthrift clause as well as the protection offered by the clause. Most states, however, have laws that recognize the validity of a spendthrift provision to prevent both voluntary and involuntary transfers of a beneficiary’s interest in the trust. An “involuntary” transfer refers to a creditor attaching a lien to the beneficiary’s interest. In New Jersey, Section 3B:31-36 of the New Jersey Revised Statutes governs spendthrift provisions, making such a provision valid “only if it restrains both voluntary and involuntary transfer of a beneficiary’s interest.”
Are There Limits to the Protection Offered by a Spendthrift Clause?
While a spendthrift clause can provide both the Settlor and the beneficiary of a trust a great deal of protection against the loss of trust assets, there are limits. Most states, for example, will not extend the protection offered by a spendthrift clause to debts such a child or spousal support as well as government debts such as taxes. Some states also limit the dollar value of assets that can be protected by a spendthrift provision in a trust agreement.
Contact Living Trust Attorneys
For more information, please download our FREE estate planning worksheet. If you have additional questions or concerns about how a spendthrift clause works in a trust agreement, contact the experienced living trust attorneys at Augulis Law Firm by calling 908-222-8803 to schedule your appointment today.
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