The laws of most states, including Pennsylvania, provide for the creation of “spendthrift trusts”. A spendthrift trust is, as its name suggests, a type of trust in which the trust assets are immune from creditors of the beneficiaries of the trust. Generally, such a trust offers two protections: first, the beneficiaries cannot voluntarily sell, use as collateral, or otherwise transfer their interests in the trust (which is a restriction on beneficiaries designed to prohibit them from hurting themselves) and, second, the creditors of a beneficiary, who may have a judgment against the beneficiary, cannot attach the beneficiary’s interest in the trust. The effect of this last restriction extends to bankruptcies by trust beneficiaries. We have witnessed a recent occasion where a properly structured spendthrift trust kept a beneficiary’s interest in a trust out of his bankruptcy estate when he filed for Chapter 7.
In Pennsylvania a trust enjoys spendthrift trust status if the trust instrument restricts beneficiaries from making voluntary and involuntary transfers of trust assets. However, simply using the phrase “spendthrift trust” in the trust instrument is presumptively enough to establish these restrictions and obtain protection under Pennsylvania law.
There are limits to the protections a spendthrift trust can provide. For example, under Pennsylvania law spendthrift trust status does not protect against attachment of trust property under a valid child support order. Additionally, it should be made clear that a person cannot put his own assets into a spendthrift trust to which that person is himself a beneficiary and then claim that those assets are protected from his creditors. That is known as a “self-settled trust” and in Pennsylvania and most other states the trust assets are as available to the settlor/beneficiary’s creditors as they are to the settlor/beneficiary. This rule also has its exception, as some states and foreign jurisdictions have authorized “asset protection trusts” that purport to protect even the settlor/beneficiary’s trust interests. A more detailed article on these controversial and not always successful asset protection vehicles will follow in a future newsletter.
— Rod Fluck