Much of the estate planning process is engaged with protecting vulnerable persons from negative outside influences. We name guardians to take care of minor children, utilize Powers of Attorney to facilitate substitute decision-making for the incapacitated, and tailor trusts to protect younger beneficiaries from bad marriages and financial predators. Occasionally, lifetime trusts are necessary to protect certain beneficiaries, often referred to as spendthrifts, from themselves.
Long sanctioned under Pennsylvania law, a so-called ‘spendthrift trust’ established by one person for the benefit of another offers protection against two threats: (i) the ability of the beneficiary’s creditor to reach the trust assets before actually distributed, and (ii) the ability of a beneficiary to assign or transfer an interest in the trust. While there are exceptions to the protection offered by spendthrift trusts (for example, claims for child support and by certain taxing authorities) a properly drafted instrument is effective against a broad range of creditors and ensures that a beneficiary cannot use his interest in the trust as collateral for loans or other security, particularly important in cases where the beneficiary engages in compulsive behaviors such as gambling.
To create a spendthrift trust, Pennsylvania requires only that the language of the trust expressly reference itself as a ‘spendthrift trust.’ In spite of that, one can still get it wrong.
A recent (and factually complex) Pennsylvania case involved trust language that did prohibit involuntary transfers to creditors of the beneficiary. Because it did not use the term ‘spendthrift trust,’ however, the Court held that it did not restrain voluntary transfers and, therefore, the beneficiary’s assignment of her interest in the trust was effective and the creditor was allowed to reach the trust assets. While the facts of this particular case were byzantine, the lesson is simple: if your estate plan requires protection of a spendthrift beneficiary, consult with counsel to ensure that the protection will be effective.