The general rule is that a trust beneficiary with capacity has power to transfer his interest.[1] Spendthrift provisions are used to limit this general rule. They restrict access and control over trust income and principal and, thereby, place assets beyond the reach of most creditors.[2] Enforcement of spendthrift provisions springs from:
[A] general acceptance of [the] fundamental common-law principle that a property owner, being free either to bestow property rights and benefits upon others or to withhold them, can bestow those rights and benefits through the trust device with the settlor’s chosen conditions and restraints so long as those conditions and restraints are not, in the conventional terminology of trust law, unlawful or contrary to public policy.[3]
If the purpose of a Medicaid Trust is to benefit a Medicaid applicant, then the trust should include a spendthrift provision in addition to discretion language. A valid spendthrift provision must prohibit voluntary and involuntary transfers.[4] General language that a beneficiary’s interest is held subject to a spendthrift trust (or similar words) is sufficient to accomplish this purpose.[5] Where there is a valid spendthrift provision, the Georgia code is clear that “a creditor or assignee of the beneficiary shall not reach the interest or a distribution by the trustee before its receipt by the beneficiary.”[6] Trusts can be drafted to incorporate additional protection if the settlor is willing to redirect assets that might become subject to creditor claims; a provision providing that a beneficiary’s interest terminates or becomes discretionary upon an attempt to transfer it, or upon a creditor’s attempt to reach it, is valid except to the extent the beneficiary contributed the trust property.[7] In the context of a Medicaid Trust, inclusion of a “diversion” provision like this might deter or defeat a State attempt to reach trust assets.
Reservation of a life interest plus a general power of appointment by will or deed, whether alone or in the alternative, makes the trust accessible to the settlor’s creditors.[8] Similarly, if the settlor creates a support trust or discretionary trust for himself, there is no creditor protection.[9]
If a trust includes an in terrorem clause, that clause is ineffective unless it directs the disposition of property if the condition is violated.[10] This is significant because, with Medicaid trusts, an in terrorem clause is sometimes used with the thought that it might deter some challenges by the Department.
Notes:
1. Restatement (Second) of Trusts, § 132 and § 133. The POMS discuss spendthrift provisions as a device which prevents trust income or assets from being accessible and, therefore, countable. See POMS SI 01120.200. The ability to assign an income interest might create the same problem since a beneficiary could sell that interest in the marketplace.
2. Without a spendthrift provision, creditors can reach a beneficiary’s interest in the trust. Restatement (Second) of Trusts, § 147. “Trust ‘asset protection’ comes into play when the settlor structures the trust so that the beneficiary, her assignees, and her creditors are denied the ability to effect a transfer of the beneficiary’s trust interest.” J. Eason, Policy, Logic, and Persuasion in the Evolving Realm of Trust Asset Protection, 27 Cardozo L. Rev. 2621, 2627 (2006). Restraints on income, Restatement (Second) of Trusts, § 152, and on principal, Id., § 153, are permitted. Without spendthrift provisions, among other remedies, a creditor would have power to follow assets in the hands of beneficiaries and could have the trust attach to any traceable assets which were “misapplied.” O.C.G.A. § 53-12-301(b). Certain classes of claimants may still reach a spendthrift trust. See Restatement (Second) of Trusts, § 157.
3. J. Eason, supra, at 2631, citing Restatement (Third) of Trusts ch. 12 introductory note.
4. O.C.G.A. § 53-12-80(a); POMS SI 01120.200.B.16. See also UTC, § 103(16).
5. O.C.G.A. § 53-12-80(b).
6. O.C.G.A. § 53-12-80(c). Exceptions to this rule, which appear in O.C.G.A. § 53-12-80(d), include alimony or child support; taxes or other government claims; tort judgments; judgments or orders for restitution as a result of a criminal conviction of the beneficiary; or judgments for necessities. Subsection (d) expressly provides that “[t]he ability of a creditor or assignee to reach a beneficiary’s interest under this subsection shall not apply to the extent that it would disqualify the trust as a special needs trust established pursuant to 42 U.S.C. § 1396p(d)(4)(A) or 1396p(d)(4)(C).” What is unknown, for example, is whether subsection (d) might open a third party trust to claims for estate recovery. It should not since estate recovery is through the probate process and trust assets are not part of the probate estate.
7. O.C.G.A. § 53-12-80(e); Restatement (Second) of Trusts, § 150; see J. Eason, supra, at 2627. Other than special needs trusts and retirement plans, Georgia law does not permit the creation of a spendthrift trust that protects a beneficiary’s own assets from his or her own creditors. See O.C.G.A. § 53-12-80(f) and § 53-12-80(g). See also Restatement (Second) of Trusts, § 156(1). A beneficiary who is not the settlor is treated as such, for purposes of any spendthrift clause, during any period when the beneficiary holds a power of withdrawal to the extent of that power. O.C.G.A. § 53-12-83. This exception to spendthrift protection most likely appears in trusts where there is a Crummey (or similar) power; a power of withdrawal should not be included in a Medicaid Trust because it would render all assets subject to the power available.
8. Restatement (Second) of Trusts, § 156, Comment c.
9. Restatement (Second) of Trusts, § 156, Comments d and e. Technically, analysis of a support trust or discretionary trust is separate from analysis of the spendthrift provision, but the law generally disfavors self-settled trusts where the settlor seeks to insulate himself from his own legitimate creditors and, as a result, would reject both the spendthrift provision as well.
10. O.C.G.A. § 53-12-22(b). The same rule applies to Wills. See O.C.G.A. § 53-4-68(b).
