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Can you protect a trust from a beneficiary’s creditors?

On Behalf of | Feb 7, 2017 | Trust Administration |

You’re the trustee of a trust for a beneficiary who owes money to creditors. Can you be required to use assets in that trust to pay that beneficiary’s debt? Under California law, you may be able to avoid having to do that. However, it depends in part on how the trust was established.

A trustor or grantor (the person who creates the trust) can put protections in place against some creditors. However, it should be noted that these don’t apply if the beneficiary’s debts involve reimbursement of public benefits, criminal restitution or child or spousal support.

For example, a trust can have something called a “spendthrift clause” that prevents the beneficiary from using money in the trust to pay creditors — either voluntarily or involuntarily — unless a creditor obtains a court order. However, if the money is deemed necessary to support the beneficiary and his or her family, it can’t be taken, even with a court order.

Another way to avoid having assets in a trust taken by a beneficiary’s creditors is to set up a support trust. These trusts require that the principal and/or income of the trust be used for the support or education of the beneficiary. A creditor would have to prove that all of the money is not needed for that purpose to claim it.

Another type of trust that can provide protection against creditors is a discretionary trust. The trustee has sole discretion over distributions from a discretionary trust. A trustee may be able to help the beneficiary by making payments or purchases for the beneficiary (such as paying for housing, for example) without actually distributing the money from the trust directly to the beneficiary, where it could be taken by creditors.

Once assets are distributed from a trust, collection actions can be taken by creditors to take their share of the money. Even if they haven’t yet been distributed, a creditor can take action to require that any mandatory distributions be taken by something called “step[ping] into the beneficiary’s shoes.”

Any trustee who is dealing with issues involving a beneficiary who has creditors seeking all or part of the assets in a trust should seek experienced legal guidance to help ensure that he or she isn’t in violation of any laws or court orders.

Source: Lake County News, “Estate Planning: Trusts and judgment creditors,” Dennis Fordham, Feb. 04, 2017