Piercing the Shield: The Limits of California Spendthrift Trusts

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Introduction to Trusts

A trust is a legal arrangement where one party, known as the settlor, transfers assets to a second party, the trustee. The trustee then holds and manages these assets for the benefit of a third party, the beneficiary. Trusts are used for various purposes, such as estate planning, tax mitigation, and asset protection.

The most commonly used trust, known as a living trust or revocable trust, allows the settlor to maintain control over their assets during their lifetime and determine how they are distributed after their death. However, it’s important to note that a living trust doesn’t offer substantial asset protection. If a settlor is sued, their assets in a revocable trust can still be reached by judgment creditors.

For stronger asset protection, one might consider a different type of trust, such as a spendthrift trust. These trusts, like all trust types, need to be carefully drafted by an attorney to ensure they fulfill their intended purpose.

Understanding Spendthrift Trusts

A spendthrift trust is a type of trust that includes provisions designed to protect the beneficiary’s interest in the trust. The aim of a spendthrift provision is to prevent a beneficiary from prematurely assigning their interest in the trust to someone else and to safeguard the assets within the trust from being claimed by the beneficiary’s creditors.

Key Provisions and Exceptions in Spendthrift Trusts

If the trust instrument or legal document outlining the details of the trust includes a spendthrift clause, it generally means the beneficiary’s interest in the trust income or principal cannot be transferred or used to satisfy a money judgment until it is actually disbursed to the beneficiary. However, exceptions exist to this general rule in California.

Creditors and Spendthrift Trusts

Under certain conditions, a judgment creditor of the beneficiary can reach amounts of principal that have become due and payable under the terms of the trust instrument. In addition, court orders can direct the trustee to use future trust payments to fulfill a beneficiary’s child or spousal support obligations or to pay income or principal to satisfy a restitution judgment against the beneficiary. Public child support or spousal support obligations can also be satisfied from future trust payments by the trustee under court orders. If the beneficiary is due more money than is needed for their education and support, the court can direct the excess to the judgment creditors.

Case Law and Spendthrift Trusts

One significant exception was established in the 2017 case, Carmack v. Reynolds. The court ruled that a bankruptcy trustee could access the beneficiary’s interest in the spendthrift trust up to the full amount of principal currently due and payable and up to 25 percent of anticipated future payments, considering the beneficiary’s and their dependents’ support needs.

Settlors as Beneficiaries

Importantly, if the settlor is also the beneficiary of the spendthrift trust, the spendthrift clause cannot protect against the settlor’s transferees or creditors. Consequently, a settlor cannot use a spendthrift trust to protect their assets from their own creditors.

Conclusion

Although spendthrift trusts offer potential asset protection advantages, their effective implementation requires the assistance of a competent attorney. Such legal counsel ensures the trust’s terms are drafted carefully to comply with the law and to serve their intended purpose effectively.

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