Parents, Children, and Spendthrift Trusts

We previously discussed ways to protect gifted or inherited property from the claims of a child’s spouse, from the viewpoint of the parent making the transfers. It noted that the law already protects the amount of the gift or inheritance, plus any appreciation not caused by marital funds or efforts.

A need for protection does exist to the extent that the transferred property experiences “active appreciation” after the transfer—appreciation that is caused by marital funds or efforts. The best way to protect active appreciation from marital claims is to ask your child and your child’s spouse to sign a premarital agreement waiving these claims.

What if your child is unwilling or unable to sign an agreement? You can achieve a similar result by use of a trust.  Money or property placed in trust is managed by a third person, the trustee, for the benefit of your children. The law requires the trustee to act with your child’s interests in mind, and the instructions in the trust document must be followed.

Unfortunately, you cannot avoid a claim by your child’s spouse simply by creating a trust. As previously stated, there is not a need for a trust to protect the initial amount transferred to your child, plus future appreciation not caused by your child’s funds or efforts. The purpose of a trust would be protect active appreciation. But if your child simply has an interest in the trust, active appreciation in value of your child’s interest in the trust can be marital property.

To avoid an active appreciation claim, you have to create a specific kind of trust—a spendthrift trust.  A spendthrift trust gives your child no legal interest in the trust at all.  In theory, there is nothing to which a marital claim can attach.  Instead, the trustee is given discretion to make transfers of the trust property to your child, as the trustee believes necessary for your child’s welfare. Because your child has no right to receive any set amount from the trust, a spendthrift trust is more protected from marital claims than an ordinary trust. Be aware, however, that there are risks with a spendthrift trust.  First, you must very carefully select a trustee who you trust to make decisions regarding your money. A trusted friend is a good first choice, but your child is likely to live longer than most of your friends.

You should have a long-term plan for who will be the trustee after your generation has passed.

Second, it is not 100% certain that a spendthrift trust will defeat marital claims. The more often your child receives money from the trust, the stronger the argument becomes that your child actually has a de facto property interest in the trust, one that is subject to marital claims. Also, if your child exercises actual control over the trust property, that would increase the risk of a court finding a de facto property interest. Finally, it is possible that a regular pattern of distributions from a spendthrift trust might be treated as income for purposes of alimony.

In addition, a spendthrift necessarily deprives your child of complete control over the property. It is impossible to completely predict the future in advance, and there are probably various ways in which lack of control could be harmful, especially in adverse conditions, such as a strong nationwide recession. Careful selection of a trustee can perhaps limit these risks, but the risks still exist. You will need to consider whether your desire for protection is strong enough to justify the risks of creating a spendthrift trust.

Overall, if you do not expect the value of a gift or devise to your children to grow due to your child’s funds or efforts, you do not need any special protection. If you do expect active appreciation to occur, the best protection for your child is a premarital agreement.  If a premarital agreement is not possible, the best measure available is a spendthrift trust. Such a trust poses certain risks, however, and it probably does not offer as much protection as a premarital agreement.