Trusts can be structured to provide superior asset protection against creditor claims. A spendthrift trust provision is a specific statement or statements in a trust document that specify how and when creditors of the trust beneficiary can reach the trust assets. This type of provision may or may not be upheld, depending on who created the trust, what the other provisions of the trust are, and what state law governs the trust.

Types of Trusts

There are two types of trusts, namely, self-settled trusts and non-self-settled trusts.

Self-settled trusts are irrevocable trusts created by the same individual who is the beneficiary of the trust. Irrevocable means that the trust creator cannot un-do the trust once it is created and funded. Non-self-settled trusts are trusts that were created by one or more persons for the benefit of third persons. The trust creator and the trust beneficiary are not the same person.

Very few states will uphold spendthrift trust provisions that are included in a self-settled trust (for example, the State of Colorado does permit self-settled spendthrift trusts). The thought is that it violates public policy for an individual to be able to place his or her assets in trust for his or herself and thereby use a spendthrift trust provision to place trust assets from the individual’s own creditors.

On the other hand, almost all jurisdictions provide full protection for trust assets held in non-self-settled spendthrift trusts.

Placing Trust Aseets Beyond the Reach of Creditors

There are a number of other trust provisions that may compromise the protections provided by self-settled spendthrift trusts (in the states that afford asset protection to these trusts) and for non-self-settled spendthrift trusts.

The general rule is that if the trust beneficiary has the power to get at the trust assets, then the trust beneficiaries creditors have the power to get at the trust assets.

Thus, the asset protection feature of an otherwise valid non-self-settled spendthrift trust may be compromised if the trust beneficiary is also the trustee so long as the trust gives the trustee the power to make trust distributions. In this case the trust beneficiary has the ability to get at the trust assets via his or her ability to make trust distributions.

The trustee does not have to be the trustee and, if he or she is the named trustee, then he or she does not have to be given the power or authority to make trust distributions. There are several ways to structure trusts for this purpose.

1. Sprinkle or spray trusts. Sprinkle or spray trusts provide the trustee (who, presumably, is not the trust beneficiary) with the ability allocate trust distributions amongst a class of beneficiaries.For example, the spray trust beneficiary may opt to make a distribution to one trust beneficiary and not to make distributions to another trust beneficiary.
2. Discretionary trusts. Discretionary trusts provide the trustee (again, who is presumably not the trust beneficiary) with the ability to decide if any trust distributions are to be made to any trust beneficiary.For example, a discretionary trust may provide that the trustee may or may not make distributions to any one or more beneficiaries. If any one trust beneficiary turns out to have creditor issues, the trustee can simply opt not to make distributions to that trust beneficiary.
3. Shifting trusts. Shifting trusts provide that upon the occurrence or nonoccurrence of a certain event or lapse or passing of time the right to trust distributions inure to different trust beneficiaries.For example, a shifting trust may provide that a trust beneficiaries distributions will go to a second trust beneficiary so long as the first trust beneficiary is married and has not executed a valid pre/post marital agreement.

   Similarly, suspension trusts can provide that upon the occurrence or nonoccurrence of a certain event or lapse or passing of time trust distributions halt. For example, the suspension trust may provide that trust distributions will cease immediately if a civil lawsuit is filed against the trust beneficiary.

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