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Should you fund a spendthrift trust?

If you have children and grandchildren and are drafting an estate plan, you may have run into some sticky situations. A particular problem many people face is that they have one or more beneficiaries who have proven to be financially irresponsible in the past.

It's disheartening to think that the assets you accumulated over a lifetime — or in some cases, generational wealth — could be dissipated in a short time through a beneficiary's fiscal mismanagement. Yet, some people appear incapable of competently managing their finances.

When there is a problem

When listing all of your intended beneficiaries, consider the lifestyle and temperament of each. Is one of your adult children addicted to alcohol or drugs? Do they have a fondness for sports betting or hanging out at the track?

Or maybe it's a grandchild who is in an unstable marriage and you worry that their spouse could mismanage the funds you leave to your grandchild. Regardless, your concerns can be addressed in your estate plan.

What can a trust grantor do?

There are ways to protect your beneficiaries from their worst intentions and/or unsavory outside influences. You can create and fund a spendthrift trust. Here's how it works:

  • Spendthrift trusts have oversight.

You will appoint a trustee — an attorney, a trust management company, a family member or trusted friend — who will oversee the trust and pay out periodic disbursements to your beneficiary, who will not have access to the principal trust assets to deplete them.

  • They can be nearly creditor-proof.

The assets in the trust will have full protection from the beneficiaries' creditors. However, once the disbursements are made to the beneficiaries, they may be attached by the creditors.

Such is also the case when the beneficiary is married. In most cases, the funds from the trust are protected as separate property. Commingling the funds at a later point can erase this protection, however.

Spendthrift trusts much like other trusts

You set up a spendthrift trust in the same way that you draft other trusts. The sole difference is the spendthrift provision that you add. You may want to use a regular trust with some beneficiaries and a spendthrift trust with others.

Many estate planning professionals advise against appointing a co-beneficiary as trustee over the spendthrift trust, however. This is especially true if it is a sibling or other family member, as this can foment bad blood between the co-beneficiaries and lead to generations-long rifts.

While they are not necessary for everyone, spendthrift trusts are an effective estate-planning tool that can be tailored to your family's particular circumstances of situation.

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