SPENDTHRIFT TRUSTS: Are your assets safe from creditors?

By Craig T. Matthews, Esq. Estate Planning

Do you have a revocable trust with a spendthrift provision?  Do you think it will protect your assets from creditors?  Do you think your trust will protect your beneficiaries from those creditors, during your lifetime?  Think again!  Under Ohio Rev. Code § 5805.06, the protections of a revocable trust can be broken by creditors, regardless of the spendthrift provision and your expectations.[1]

A revocable trust is vulnerable to the creator of the trust or settlor’s creditors, during his lifetime.  Under Ohio Rev. Code § 5805.06, “[w]hether or not the terms of a trust contain a spendthrift provision . . . during the lifetime of the settlor, the property of a revocable trust is subject to claims of the settlor’s creditors.”[2]  A settlor is defined as “a person, including a testator, who creates, or contributes property to a trust.”[3]  Furthermore, spendthrift provisions are created to protect the beneficiaries’ interests from the beneficiaries’ creditors, not the settlor’s, or else debtors could hide assets in trusts for protection from their creditors, which would be in violation of public policy.[4]  Therefore, a revocable trust is subject to the claims of a settlor’s creditors while the settlor is alive.

Additionally, a trust’s revocability is not altered by the legal capacity of the settlor, even if the settlor has assigned his power of attorney to another.  Revocable means “revocable at the time of determination by the settlor alone or by the settlor.”[5]  However, a revocable “trust’s characterization as revocable is not affected by the settlor’s lack of capacity to exercise the power of revocation, regardless of whether an agent of the settlor under a power of attorney, or a guardian of the person or estate of the settlor is serving.”[6]  Thus, regardless of who maintains the power of attorney for the settlor of the revocable trust, the property of the trust is subject to the settlor’s creditors.

Even if the trust is not on its face revocable, the existence of the settlor’s power to withdrawal makes it revocable.  If the settlor maintains the power to withdrawal, the trust will be characterized as a revocable trust.  Under Ohio Rev. Code § 5805.06, “[t]he holder of a power of withdrawal is treated in the same manner as the settlor of a revocable trust to the extent of the property subject to the power during the period the power may be exercised.”[7]  Furthermore, it has been held that the power to withdraw money from a trust is similar to having money in the bank.[8]

In summation, a revocable trust is vulnerable to creditors seeking repayment for debts incurred during the settlor’s lifetime, regardless of a spendthrift provision.  Additionally, if the trust is revocable, the revocability is not affected by the settlor’s legal capacity.  Furthermore, even if the trust is not considered revocable on its face, the provisions permitting the settlor to withdrawal makes it revocable.  Therefore, a revocable trust is vulnerable to creditors seeking repayment for debts from a settlor, regardless of spendthrift provisions and expectations, so BEWARE.