Now, before you run off to your local attorney to deposit all of your assets into the hands of a trustee let me explain a bit further. As you may recall from the last article the structure of a trust allows for a clever division of title among the trustee and the beneficiary. The trustee holds legal title to the property of the trust while the beneficiary holds beneficial title to the property. Further, most trusts have a provision called a Spendthrift Clause. This clause was originally designed to prevent good for nothing spendthrift trust babies from burning through their trust funds. The courts began to permit the use of limiting language within trusts that would prevent the beneficiary from having the right to demand, pledge, assign or transfer the property of the trust. Originally this applied to trusts which were established for the benefit of a beneficiary by another person (parent, grandparent, etc.). They wanted to make sure that the money was there until the trust terminated under the terms of the trust. The logic behind allowing the spendthrift clause should be clear now that we have discussed the division of title. How could the beneficiary demand, pledge, assign or transfer property for which he does not have legal title? The only title that the beneficiary holds is the beneficial title. This beneficial title would be the right to enjoy the spoils of the property, at the discretion of the trustee or under the mandatory distribution standard (if present) of the trust.
So, when a grantor would transfer property into a trust (either during life or at death) for the benefit of another, and they included a spendthrift clause, they were able to effectively protect the beneficiaries trust interest from creditors and from the beneficiary himself. The use of spendthrift clauses is common place now and I would venture to say that it has now achieved the status as mandatory boilerplate language for all new trust instruments.
The challenge that I often face when I talk with clients about this is the continued perception of trusts being solely within the realm of the wealthy. Even with this information they still believe that their family wealth (whatever that amount may be) isn’t enough to justify the use of a trust for their spouse, children or grandchildren. And I will be honest in saying that in some cases this may in fact be true. There is a bit of administrative work that goes along with a trust but in my opinion the burden is often outweighed by the peace of mind that such powerful creditor protection offers.
I like to explain the potential applicability of the trust to clients through the use of a very simple example. Husband dies with a life insurance policy with a death benefit of $1,000,000 payable to his spouse. The policy is processed after the husband passes away and within a few weeks of his death the check is delivered to the surviving spouse. She receives the check, gets in her car and drives to the bank. On the way to the bank she is fumbling with her cell phone and causes a terrible automobile accident. Passengers in the other car are seriously injured. A lawsuit commences and a judgment of $1,000,000 is rendered against the surviving spouse. Well, since she is the owner of the legal title to that money it will be subject to satisfaction of that judgment.
Now, same set of facts but instead of having the surviving spouse named as the designated beneficiary of the policy the husband named a trustee of a family trust (the surviving spouse could be the trustee) as the beneficiary of the policy. The surviving spouse would be the beneficiary of the trust estate during her lifetime. The check is received by the surviving spouse; she heads to deposit the check in the trust account, the accident occurs and the lawsuit is commenced. Judgment is rendered again the surviving spouse for $1,000,000. The difference in the outcome is that the $1,000,000 received by the trustee of the trust is not her property. She does not hold legal title to that property in her individual name. That property belongs to the trust, for which she only holds a beneficial interest in her individual name. Therefore the judgment creditor could collect against all of her personal assets but they would not be able to touch the trust funds. That is a dramatic and powerful result that can be achieved through some rather simple estate planning.
A properly drafted spendthrift trust will allow family funds to be protected from the claims of creditors, divorces and irresponsible beneficiaries. Does it have a place in the estate planning for the mega-wealthy? Yes, usually due to a combination of the creditor protection aspect along with some tax planning. But it also has a place in the plans for the average client who simply wants to offer his or her family the highest level of protection against the unforeseen.
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