What Is a Spendthrift Trust?

Anh Bishop is a senior director and wealth planning attorney for the Sophisticated Planning Strategies team at Northwestern Mutual. 

Being able to leave a large inheritance to your heirs is, for many people, an exciting possibility. After all, there are few things as fulfilling as knowing that your loved ones will be financially taken care of after your death. But for some people it can also be a source of anxiety. You might be worried that an heir is at risk of squandering the inheritance or losing most of it in divorce proceedings. 

The good news is there are strategies you can use so that your heirs will be less likely to deplete their inheritances too quickly. One such strategy is to establish a spendthrift trust, which also protects your assets from creditors. 

Below, we take a closer look at what a spendthrift trust is, how it works, and the pros and cons that come with leveraging one. We also offer guidelines that you can use to decide whether or not a spendthrift trust makes sense for your estate plan.   

What is a spendthrift trust? 

A spendthrift trust is a type of trust that establishes certain conditions, or terms, that must be met for a beneficiary to receive assets held within the trust. These terms prevent a beneficiary from directly accessing the trust’s assets. While the terms of a spendthrift trust can vary, they are typically designed to release assets to the beneficiary slowly over time rather than all at once. 

For example, the terms of a spendthrift trust might dictate that the beneficiary receives a certain sum of money on a monthly, quarterly or annual basis. Or they might specify that the beneficiary will receive interest and dividend payments on a quarterly basis while never gaining direct access to the trust’s underlying assets.  

The biggest benefit of a spendthrift trust is that the beneficiary cannot access all of an inheritance at once, so you have less worry that they could waste it through poor financial decisions. With the proper design, a spendthrift trust can become a lifelong source of income for your heir. Another appealing aspect of a spendthrift trust is that the assets are protected from creditors. 

How does a spendthrift trust work? 

At its heart, a spendthrift trust works like any other trust: The grantor establishes the trust, funds it with property (or assets), selects a trustee who will be responsible for managing the assets, and names a beneficiary or beneficiaries who will receive the trust’s assets. What sets a spendthrift trust apart from other types of trusts is the inclusion of a spendthrift clause or spendthrift provision. 

What is a spendthrift clause? 

A spendthrift clause is special wording that essentially establishes the trust itself as the owner of the assets that it contains. This clause establishes the asset disbursement schedule that prevents the beneficiary from receiving all of the assets at once. A spendthrift clause may also protect trust income and principal from the claims of a beneficiary's creditors.

Are spendthrift trusts revocable? 

A spendthrift trust can be either revocable or irrevocable, depending on how they are initially established.  

If you establish a revocable spendthrift trust, that means the terms of the trust can be modified in the future—for example, if your beneficiary’s financial situation and expenses change, or if they mature financially to a point where you believe they are no longer at risk of wasting their inheritance.  

If you establish an irrevocable spendthrift trust, that means the terms of the trust can never be changed. While this provides less flexibility, it can provide greater protection against estate taxes and probate.  

Can a spendthrift trust be broken? 

Generally speaking, no.  

You, as the trust’s grantor, may be able to make changes to the trust’s terms if it is revocable. But it is very difficult—if not impossible—to actually break or dissolve the trust once it is established. Any attempts to do so would need to work through the courts. 

Likewise, the trust’s beneficiary (and the beneficiary’s creditors, if any) has no power to break a spendthrift trust or otherwise seize the assets it contains.  

Are spendthrift trusts discretionary trusts? 

No. With a discretionary trust, the trustee has a certain level of control over when and how assets are distributed to the trust’s beneficiaries. They can, for example, potentially refuse a disbursement if the beneficiary has gone against the terms of the trust. They may also be able to refuse a disbursement if they are deemed to be at risk of engaging in financially risky behavior.  

A spendthrift trust works differently. The trustee must comply with whatever distribution schedule is established in the terms of the trust. 

How much does it cost to set up a spendthrift trust? 

The cost of setting up a spendthrift trust is similar to that of other trusts and can vary depending on various factors, such as the complexity of the trust, the jurisdiction and the professional fees involved. Here are some potential costs to consider: 

• Legal Fees: Hiring an attorney experienced in estate planning or trust law is advisable. The fees charged by attorneys can vary depending on their expertise and location. Simple spendthrift trusts may have lower legal costs, while more complex trusts with specific provisions can be more expensive. 

• Trustee Fees: If you appoint a professional trustee or a corporate trustee, they may charge fees for their services. These fees can vary based on the level of involvement and the assets held within the trust. Some trustees charge a percentage of the trust assets, while others may charge an hourly or flat fee. 

• Administrative Costs: Spendthrift trusts involve ongoing administrative tasks, such as accounting, tax preparation and recordkeeping. These costs can vary depending on the complexity of the trust and the services required. 

• Filing Fees: There may be filing fees associated with creating the trust and registering it with the appropriate jurisdiction. These fees can vary depending on the location. 

An attorney or a trust professional can assess your specific needs and provide a breakdown of the associated costs. 

Pros and cons of spendthrift trusts in estate planning 

Before establishing a spendthrift trust, it’s important to understand both the benefits and potential drawbacks that it may include. 

Benefits of a spendthrift trust 

• Protection against poor financial decisions: Because your beneficiary will not receive their entire inheritance at once, there’s less likelihood that they will lose their inheritance to reckless spending, fraud, scam or other poor financial decisions. 

• Protection from creditors: Because the assets contained in the trust do not belong to the beneficiary but to the trust itself, they are often protected from creditors and lawsuits. 

• Potential source of income: The disbursal schedule established by a spendthrift trust can be used to create a steady, guaranteed source of income for your beneficiary—potentially for the rest of their life. 

• Tax control: The assets contained within a spendthrift trust are typically excluded from your estate, which helps protect them from estate taxes. 

• Probate avoidance: As long as the trust is established and funded before you die, trust assets will not be subject to probate after you pass. 

• Privacy: While the contents of a will cannot remain private, the terms of a spendthrift trust often can. 

Drawbacks of a spendthrift trust 

• Costs: While there are fees involved with establishing any trust, the ongoing administration of a spendthrift trust typically translates to higher costs over the trust’s lifetime. 

• Complexity: Establishing a spendthrift trust requires a thorough understanding of estate law and trust law, on both the federal and state level. 

• Inflexible: If you establish an irrevocable spendthrift trust, you will not have the flexibility to change its terms—even if your beneficiary matures or their financial situation changes.  

Who should use a spendthrift trust? 

Spendthrift trusts are typically used when someone wants to leave a large inheritance to their heirs but worries that the beneficiary may not make the soundest financial decisions. This can include instances where your beneficiary: 

• Is young and has not developed responsible financial habits. 

• Is disabled and in need of lifelong support or income. 

• Has a track record of impulsive or reckless spending. 

• Has a large amount of debt or may incur significant debt. 

• Is at risk of divorce or is actively involved in divorce proceedings. 

• Is at risk of being sued. 

• Is at risk of being scammed or falling victim to fraud. 

• Has a history of addiction, which could lead to poor spending habits. 

As you consider the best way to leave an inheritance, your Northwestern Mutual financial advisor can help you weigh your options. That way, you can be sure your estate plan truly meets your goals. 
 
This publication is not intended as legal or tax advice. Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation.