As you may already know, a Last Will and Testament is not the only estate planning tool available for gifting assets to loved ones or other beneficiaries. Many people choose to use a living trust in addition to, or in lieu of, a Will to pass down estate assets. One reason people often choose to use a trust to distribute assets is the ability to direct when assets are distributed and even how assets are used by the beneficiaries. The benefit you gain by being able to dictate how trust assets are used, however, could be threatened if a beneficiary has the ability to sell or encumber her interest in the trust. The Carmel area trust attorneys at Frank & Kraft explain whether a beneficiary has the right to sell his/her benefits in a trust.
What Is a Living Trust?
A trust is a relationship whereby property is held by one party for the benefit of another. All trusts are broadly divided into two categories – testamentary and living trusts. A testamentary trust is one that does not activate until the death of the Settlor, usually triggered by a term in the Settlor’s Last Will and Testament. A living trust, as the name implies, is a trust that activates as soon as all the formalities of creation are in place. Living trusts can be further sub-divided into revocable and irrevocable living trusts. A revocable living trust is one that can be modified, amended, terminated, or revoked at any time, and for any reason, by the Settlor, whereas an irrevocable living trust cannot be modified or revoked for any reason by the Settlor once the trust is active. Because a testamentary trust does not activate until the death of the Settlor it is always revocable up to the point of the Settlor’s death.
Selling or Encumbering Trust Assets
The Settlor (creator) of a living trust creates the terms of the trust within the trust agreement. Those terms determine how and when the trust assets are distributed to the beneficiaries of the trust. Those terms might call for a beneficiary to receive interest only for several years, or to receive staggered disbursements instead of a lump sum. For a beneficiary in need of money, knowing that a disbursement is coming at some point down the road, but isn’t available right now, can be frustrating. This is especially true if the beneficiary is having financial problems. On the other hand, the Settlor may have created a trust and distributed assets through the trust for exactly that reason – to prevent a beneficiary from squandering a lump sum of money. What if the beneficiary decides to simply sell his/her interest in the trust or use that interest as collateral for a loan? Can a beneficiary do that?
As a general rule, trust property cannot be sold outright by a beneficiary; the property must be first transferred to the beneficiary and placed in his name. The Settlor’s intent, the number of beneficiaries, and/or the existence of a spendthrift clause can all impact a beneficiary’s right to sell trust assets as can the state in which the trust was executed.
The first place to look for an answer if you want to know if a beneficiary can sell his/her interest in the trust is the trust agreement. The provisions of the trust agreement govern the administration of the trust and must be followed by the Trustee. If a provision explicitly states that an heir or beneficiary cannot sell/encumber trust property, the Trustee is not permitted to allow a beneficiary to sell/encumber the property. The same is true for the trust intent. If selling/encumbering the trust property would be contrary to the stated intent of the trust, it cannot be done.
In addition, the Trustee is required to treat beneficiaries impartially and to always consider all beneficiaries (both current and future) when making trust decisions. If there is more than one beneficiary, The trustee cannot transfer property for one beneficiary to sell if it hurts the other beneficiaries’ interests. The only possible exception to this rule would be if the trust agreement specifically authorized doing so because the provisions of the trust agreement govern the trust.
Finally, if the trust agreement includes a spendthrift clause it will specifically prevent beneficiaries from transferring any portion of their interest in the trust to another party. Most states have upheld the validity of spendthrift provisions although some have not.
Contact Carmel Area Trust Attorneys
For more information, please join us for an upcoming FREE seminar. If you have additional questions or concerns regarding trusts, contact the experienced Carmel area trust attorneys at Frank & Kraft by calling (317) 684-1100 to schedule an appointment.
Mr. Kraft assists clients primarily in the areas of estate planning and administration, Medicaid planning, federal and state taxation, real estate and corporate law, bringing the added perspective of an accounting background to his work.
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