The Spendthrift Clause

April 13, 2006

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When setting up an asset protection trust for yourself, it must have a spendthrift clause. This prevents the beneficiary of a trust from voluntarily or involuntarily transferring any current or future rights in the trust. In other words, among other things, it prevents the creditors of the beneficiary from reaching the trust's assets.

The term "self-settled spendthrift trust" refers to a trust with a spendthrift clause, where the trustor also is a beneficiary.

The only impediment to using such a trust has been the fact that until 1997 every state (with relatively minor exceptions) has provided that a self-settled spendthrift trust clause is invalid.

States based this rule on the grounds that it is against public policy for an individual to put property into a trust and out of the reach of his or her creditors, when the individual still can benefit from the property.

Significantly, as of 1997, Alaska and Delaware allow such trusts to operate.

Of course, outside of the United States, other countries have their own rules, and some jurisdictions do allow offshore trusts that use a spendthrift clause as well.

On the other hand, the use of a spendthrift clause in a trust established for a different beneficiary (e.g., a child) has always been recognized as valid. Thus, in a children's trust, a bypass trust, a QTIP trust, a life insurance trust, etc., a spendthrift clause should always be used.

Note that, when the trust is established for a separate beneficiary, the fact that the trust is revocable does not invalidate the spendthrift clause, as it imparts no rights in the beneficiary. However, the beneficiary should not be a trustee, and the trust should not provide for mandatory distributions of income or principal. Where mandatory distributions of income or principal exist, a creditor would be able to reach the distributions when they occur.