Many people include a spendthrift clause in revocable trust documents expecting it will protect assets from creditors. The reality is more nuanced. Whether the clause provides meaningful protection depends on who is seeking protection and at what point in time.
Understanding how spendthrift provisions actually work helps you create realistic expectations about what your trust can and cannot accomplish.
What Is a Spendthrift Clause?
A spendthrift clause is a provision in a trust that restricts beneficiaries from transferring their interests and protects trust assets from beneficiaries’ creditors. According to the Legal Information Institute at Cornell Law School, a spendthrift clause limits the ability of assets to be reached by the beneficiary or their creditors.
The clause typically prevents the beneficiary from voluntarily assigning, pledging, or selling their interest in the trust. It also prevents creditors from attaching or garnishing the beneficiary’s trust interest before distributions are actually made.
Spendthrift provisions serve two purposes: protecting beneficiaries from their own poor financial decisions and protecting the trust assets from claims by the beneficiaries’ creditors.
The Problem with Revocable Trusts
Here is the critical issue: a spendthrift clause in a revocable trust provides essentially no protection to the grantor during their lifetime.
Under the Uniform Trust Code, adopted in most states, and consistent common law principles, the property of a revocable trust is subject to claims of the settlor’s creditors during the settlor’s lifetime. This rule applies whether or not the trust contains a spendthrift provision.
The Virginia Code section on creditor’s claims states this clearly: during the lifetime of the settlor, the property of a revocable trust is subject to claims of the settlor’s creditors. This is the majority rule across American jurisdictions.
The reasoning is straightforward. Because the grantor retains the power to revoke the trust and reclaim the assets at any time, the law treats those assets as still belonging to the grantor for creditor purposes. The grantor cannot use a trust they control to shield assets from their own creditors. That would allow people to enjoy the benefits of their wealth while avoiding legitimate obligations.
Self-Settled Trust Limitations
The inability to protect your own assets through a spendthrift trust you create for your own benefit is a fundamental principle of trust law.
As one trust law resource explains, to prevent individuals from creating trusts to defeat their own creditors, the laws of most states provide that a spendthrift clause in a trust document does not protect the beneficiary to the extent that the beneficiary is also the person who created the trust.
This is called the self-settled trust doctrine. If you create a trust, transfer your assets to it, and retain a beneficial interest, creditors can generally reach the assets you transferred, regardless of any spendthrift language.
Massachusetts courts have confirmed that a self-settled or discretionary trust cannot be used to protect assets from creditors because the grantor created a discretionary trust for his own benefit. In such cases, creditors can reach the maximum amount the trustee could distribute to the grantor or beneficiary.
When Spendthrift Clauses Do Work
The spendthrift clause in a revocable trust becomes effective and meaningful after the grantor dies. At that point, several things change.
First, the trust typically becomes irrevocable. The grantor can no longer revoke it or reclaim the assets because the grantor is deceased.
Second, the beneficiaries are now someone other than the grantor. The trust benefits the grantor’s children, spouse, or other designated beneficiaries.
Third, the spendthrift clause now protects those beneficiaries from their own creditors. If a beneficiary has financial problems, creditors generally cannot force distributions from the trust or attach the beneficiary’s interest before distributions are made.
Protection for Beneficiaries
Once the grantor dies and the revocable trust becomes irrevocable, the spendthrift clause provides real protection for beneficiaries.
A beneficiary’s creditors generally cannot force the trustee to make distributions to satisfy the beneficiary’s debts. Creditors can only attempt to collect after money has been distributed to the beneficiary. The beneficiary cannot pledge future distributions as collateral or sell their trust interest at a discount to raise cash. In many jurisdictions, trust assets can be structured to provide protection in divorce proceedings since the trust interest may not be considered the beneficiary’s personal property.
This protection can be valuable for beneficiaries who struggle with financial management, face professional liability risks, have creditor problems, or might go through divorce.
Exceptions to Spendthrift Protection
Even after the grantor dies and the trust becomes irrevocable, spendthrift clauses do not provide absolute protection. Most states recognize certain exception creditors who can reach trust assets despite spendthrift provisions.
Child and spousal support claims are the most common exception. Courts generally allow spendthrift trusts to be reached for support obligations to children or former spouses.
Government claims for taxes or other obligations may be enforceable against spendthrift trusts in some circumstances.
Providers of necessities such as food, shelter, or medical care may have claims in some jurisdictions.
Judgment creditors can typically garnish trust distributions after they are made to the beneficiary, even if they cannot reach the trust assets beforehand.
Domestic Asset Protection Trusts
A handful of states have enacted statutes allowing domestic asset protection trusts (DAPTs), also called self-settled spendthrift trusts. These states include Nevada, Delaware, Alaska, South Dakota, Wyoming, and others.
In these jurisdictions, a person can create an irrevocable trust for their own benefit with spendthrift provisions that may protect assets from future creditors, subject to various requirements and limitations.
However, a DAPT is very different from a standard revocable living trust. It must be irrevocable, meaning the grantor gives up control. It requires meeting specific statutory requirements. It typically involves a waiting period before protection attaches. It may not be honored by courts in other states.
If you want creditor protection for your own assets during your lifetime, a domestic asset protection trust in an appropriate jurisdiction may be an option, but it requires giving up far more control than a revocable trust.
Planning Implications
Understanding how spendthrift clauses work should inform your estate planning.
If your primary goal is protecting assets from your own creditors during your lifetime, a revocable trust with a spendthrift clause will not accomplish that goal. You would need to consider irrevocable trust options, asset protection trusts in appropriate jurisdictions, or other planning strategies.
If your goal is protecting your beneficiaries after you die, a spendthrift clause in your revocable trust can be very valuable. Once you pass away and the trust becomes irrevocable, the clause protects your beneficiaries’ interests from their creditors.
Most estate planning attorneys include spendthrift provisions in revocable trusts as a matter of course. Even though the clause does not protect the grantor, it protects beneficiaries after death, which is when the trust’s primary purpose takes effect.
Consult a Professional
Spendthrift provisions involve complex interactions between trust law, creditor rights, and state statutes that vary considerably by jurisdiction. Before relying on any spendthrift protection or deciding whether to include such provisions in your trust, consult with an estate planning attorney familiar with your state’s laws.