News & Thought Leadership from Sulloway & Hollis

April 16, 2023

Revocable Trusts and Creditor Protection

A diverse cross-section of estate planning clients choose to create and fund revocable trusts in order to achieve some combination of the following goals:

  1. avoiding probate (thereby reducing post-mortem expenses and delay);
  2. exercising long-term control over trust assets (often in connection with shares created for the benefit of children, young adults, or individuals with special needs);
  3. keeping dispositive provisions hidden from public view and/or
  4. allowing for the seamless transfer of property management in the event of future incapacity.

Clients occasionally ask whether revocable trusts offer protection against creditors. As discussed below, revocable trusts may be used to protect a beneficiary’s share from the existing and future creditors of that beneficiary. However, revocable trusts do not shield a settlor’s assets from the settlor’s creditors (whether such creditors exist at the time of trust creation or come into being post-signing). RSA 564-B:5-505(a) makes clear that property titled in the name of the settlor’s revocable trust is subject to creditor claims throughout his or her life. Upon the settlor’s death, such property is subject to creditor claims to the extent the assets belonging to the settlor’s probate estate, if any, are insufficient to satisfy such claims. See RSA 564-B:5-505(b).

Conversely, revocable trusts may be designed to protect a beneficiary’s interest from his or her current and future creditors. While the settlor is living, a beneficiary has no property interest in the trust property; instead, the beneficiary possesses what is sometimes referred to as a ‘mere expectancy.’ Only upon the death of the surviving settlor, when the trust becomes irrevocable, does a beneficiary’s interest become susceptible to creditor claims.

However, RSA 564-B:5-502(d) states that if a beneficiary’s trust interest is subject to a valid spendthrift provision, his or her creditors cannot reach the interest. Instead, creditors may only reach trust distributions, if any, upon the beneficiary’s receipt. See RSA 564-B:5-502(d). Spendthrift provisions restrict a beneficiary’s ability to alienate his or her trust interest. For example, if B possesses a one-third (1/3) remainder interest in S’s trust, a spendthrift provision would prohibit B from selling that interest to a third party. Suppose that B borrows a sum of money from C and subsequently defaults on the loan. So long as the trust contains a valid spendthrift provision, C would be unable to secure a judgment lien against B’s one-third (1/3) share. However, if the trustee were to make a distribution of trust income or principal to B, C would be able to attach that distribution.

Many revocable trusts stipulate that a beneficiary’s share will become distributable upon the beneficiary attaining a certain age. However, if the client harbors concerns about the condition of an intended beneficiary’s marriage or financial affairs, it may be advisable to lock that beneficiary’s share in trust for the duration of his or her life. To reduce the risk that a court of competent jurisdiction would treat the assets of a spendthrift trust as available to the beneficiary, practitioners and their clients should consider appointing an independent trustee to administer the beneficiary’s share and making distributions fully discretionary. Additionally, or alternatively, practitioners and their clients may choose to evaluate the extent to which a clause terminating distributions upon the beneficiary’s divorce or upon notice of a creditor’s claim might cohere with the client’s intent while still satisfying applicable laws and public policy limitations.