Did You Know?
Research shows that people who receive an outright inheritance often squander the money.1 One study found that people of ages 20-40 lost half of all money inherited due to spending or bad investments.1 Another study found that one third of people who received an inheritance had negative savings within two years of the event.2
Who Needs a Spendthrift Trust?
You may want to consider setting up a Spendthrift Trust if you have a loved one who struggles with:
- Excessive spending;
- Drug addiction;
- A controlling partner; or
- A party lifestyle.
Why Set Up a Spendthrift Trust?
A Spendthrift Trust will help you show the kindness and compassion you have for all family members. It will help you address a common problem. On one hand, you want to leave an inheritance to someone who is financially inexperienced or irresponsible. On the other hand, you’re nervous about leaving a lump sum of money to this person. You may worry that your loved one will use the money to fuel an addiction, hand it over to creditors, or give it to a manipulative partner.
How Does a Spendthrift Trust Work?
Instead of giving a check to your loved one upon your passing, you put the inheritance in a trust. You pick a person with financial expertise to name as trustee of the trust. The trustee is responsible for managing trust funds and making sure the money is used in the best interest of your beneficiary.
It’s important to note that your beneficiary does not have full ownership of trust assets. As a result, your beneficiary cannot sell trust assets or give them away. The beneficiary can’t use trust funds to go on a spending spree or sink cash into a bad investment. Rather than have direct access to funds, the beneficiary usually receives payments from the trust on a regular basis. The beneficiary may also receive trust payouts “as needed,” as decided by the trustee. The trustee uses the wishes you set forth in your trust document as a guide for making payouts.
An Inheritance with Strings Attached
You can tailor the conditions of trust payouts. If you worry that your kids will misspend their inheritance, you can pay out their money in installments. For example, you can direct smaller payouts at age 25, 30 and 35. If your loved one suffers from addiction, you can require clean drug tests and at least 60 days of sobriety before a payout. However, there is only so much you can do protect your loved one from making bad financial decisions. Once a trust payment is in the hands of a beneficiary, he is free to spend it as wisely or unwisely as he pleases.
Leave a Legacy that Promotes Your Values
You can also draft your Spendthrift Trust to promote positive behavior. For example, if you want future generations to pursue a college education, you can trigger trust payouts by showing proof of college enrollment. If you are self-made and want to encourage your loved ones to embrace entrepreneurship, you can provide for trust payouts—in the form of a gift or a low-interest loan—if a beneficiary provides the trustee with a solid business plan.
Protect Your Financial Legacy from a Beneficiary’s Creditors
Generally, the assets in a Spendthrift Trust can’t be reached by creditors. However, state laws differ. In some states, like California, the once ironclad creditor protection offered by a Spendthrift Trust has been reduced.3 You should speak with your estate planning attorney about the creditor protection offered by Spendthrift Trusts in your state.
Choose Wisely When Selecting a Trustee
You must choose wisely when selecting the trustee of your Spendthrift Trust. Depending on the terms of the trust, your trustee may be responsible for making regularly scheduled payments. On the other hand, your trustee may have very broad authority over the timing and amount of trust payments.
In other words, your Spendthrift Trust is only as solid as the person or entity in charge of its execution. If you select the sibling of your financially inexperienced beneficiary, for example, this can make family dynamics challenging and burdensome, especially while grieving. That is why many families opt for the services of a corporate trustee. To reach your goals, you’ll need a wise, honest, and fair trustee to be the gatekeeper between your beneficiary and his or her inheritance. Your trustee must also be kind, detail-oriented, and an effective communicator, skilled in following the letter of the trust document with a decidedly human touch.
To learn more about Corporate Trustees, see How to Choose a Trustee: 4 Key Considerations.
1 Jay L. Zagorsky. (2013). Do People Save or Spend Their Inheritances? Understanding What Happens to Inherited Wealth. Journal of Family & Economic Issues. 34:64.
2 Elizabeth O’Brien. (2015). One in Three Americans Who Get an Inheritance Blow It. MarketWatch.
3 See Carmack v. Reynolds, 391 P.3d 625 (Cal. 2017).
Trust and Investment products are not federally insured, are not obligations of or guaranteed by the credit union or any affiliated entity, involve investment risks, including the possible loss of principal. This is for informational purposes only and is not intended to provide legal or tax advice regarding your situation. For legal or tax advice, please consult your attorney and/or accountant.