Living Trust Protection From Creditors

by Maggie Lourdes
Living trusts can protect assets from creditors.

Living trusts can protect assets from creditors.

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A living trust is an estate planning tool that can save time and money by bypassing the probate process after the trust maker dies. Unlike a will, a trust does not require a probate court's approval or administration. Living trusts are so called because they take effect during the maker's lifetime and can be changed or revoked at any time before his death. Besides skipping probate, living trusts can protect beneficiaries from creditors. Spendthrift clauses, as the name suggests, protect beneficiaries who spend money irresponsibly and face bill collectors. Spendthrift clauses also protect beneficiaries who accumulate bills for unavoidable reasons like medical problems or job loss.

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Spendthrifts Protect Beneficiaries

A spendthrift clause can prevent a beneficiary's creditors from reaching her living trust interests. Spendthrift clauses do not protect assets once they are released from trust and paid to beneficiaries. For example, Bob leaves a house in his living trust for Jane. Jane's bill collectors generally cannot attach the house while it remains in the trust's name. However, if the house is sold and the proceeds deposited into Jane's personal bank account, bill collectors may reach them.

Spendthrifts Prevent Assignments

Spendthrift clauses generally prohibit a beneficiary from assigning his interests in trust assets. For example, Mary leaves her summer cabin in her living trust to Bob. Bob cannot use the cabin as collateral to buy a new car by pledging, assigning or granting a lien against it. Preventing a beneficiary's control over trust assets prevents his creditors from seizing them to satisfy his debts.

Trustees Have Discretion

A trustee must follow a living trust's directions. However, spendthrift clauses generally give a trustee discretion to shield assets from creditors. For example, John's living trust states $1,000 should be paid to Sue each month. The payments are attachable by Sue's creditors once they are paid to her. The trustee may suspend payments, protecting the money by keeping it in the trust, while Sue negotiates a settlement with her creditors.

Spendthrifts Have Limitations

Spendthrift clauses do have limitations. For example, they generally do not protect a beneficiary's trust assets from overdue child support, alimony or delinquent tax bills. Spendthrift clauses typically do not protect the person who makes the living trust from his creditors. Each state has its own laws relating to the legalities of spendthrift clauses. Carefully research the law of your state or consult a trust expert with specific questions about trust protection options.