One of the primary reasons to leave property to a trust is to minimize the chance that someone can take property away from your beneficiary. Your choice of trustee will have an impact on the quality of the trust’s creditor protection. Some basic trust law will help you understand why.
A spendthrift clause is a provision in the trust that prevents any transfer of a beneficiary’s trust interest. If your trust has a spendthrift clause, your son cannot use his anticipated distributions as collateral for a debt or give his right to receive distributions to someone else. Neither can a judge. Therefore, his creditors cannot step into his shoes and access money you leave in trust for your son.
A spendthrift clause protects property while it is held in the trust. But once the trustee distributes property to your son, that property could be subject to attachment by his creditors. So, if his creditor could force the trustee to make a distribution, they could be there waiting to intercept it. Fortunately, a beneficiary’s creditors generally cannot compel the trustee to make a distribution if the trust says the distributions are discretionary. But that means your beneficiary can’t force distributions either – unless your beneficiary is also serving as Trustee.
If a beneficiary is serving as trustee, there is one further limitation for creditor protection – discretionary distributions must be limited to an “ascertainable standard,” such as “heath, education, maintenance, or support.” If the trust is designed and managed correctly, a beneficiary may serve as trustee without losing asset protection. But the trust won’t work correctly if your beneficiary/trustee cuts corners.
One reason you may want to name your beneficiary as trustee is so he or she will have more control than if a third-party trustee were in charge. But that control must be applied properly for the trust to maintain asset protection. If your beneficiary ends up in a lawsuit, the other party’s lawyer will scrutinize every trust transaction to find something that a third-party trustee would not have done.
Appointing someone other than the beneficiary as trustee minimizes these concerns. But selecting the right third-party trustee is also important. Your cousin, next-door neighbor, or sister-in-law may all do a fine job serving as trustee. But they could still make incorrect distributions, fail to maintain records, or even mishandle trust funds. If you name a professional trustee, you can be almost certain that the trust will be administered correctly. Trust companies are also bonded. So, in the unlikely event that a professional trustee manages your trust incorrectly, your beneficiary would have the ability to sue and collect damages. If your cousin mismanages the trust, he may not have any assets that your beneficiaries can get.
When you name an independent, third-party trustee, it means that your beneficiary is not in complete control. But that may be the feature that makes your trust work. Balancing control and protection is case-specific. If your beneficiary treats the trust like a personal checking account, an opposing party will likely be able to pierce the protection of the trust.
We routinely draft trusts naming beneficiaries as the sole trustee and trusts naming the beneficiaries as joint trustees. We also regularly draft trusts naming third-party trustees and distribution trustees. The choice of who should serve as trustee will depend on the specific acts of your case.