Protecting Inheritance From Schemers

Nothing gets client’s angrier than seeing a child’s ex-spouse attempt to access an inheritance. While an inheritance is not part of the marital estate, it may be subject to judgments arising from the divorce proceeding such as attorney fees.

The same misfortune arises when a child has creditor issues. Issues that may not be the fault of a child.

When leaving a loved one an inheritance, irrespective of the size of the estate, it represents a lifetime worth of work. Thus, it is important to understand that you have a right to protect it.

Trusts have been used to protect inheritances for over 120 years. Using trusts to protect an inheritance may seem unjust to creditors. After all, a creditor is someone with a valid claim over a debtor’s assets. If the claim is valid, why does the debtor get to keep his or her inheritance?

The Illinois Supreme Court grappled with this issue back in 1884 in Stieb v. Whitehead, 111 Ill. 247. In that case, a father left an inheritance for a daughter. The parent transferred rental property to a trusted third-party (the “trustee”) to manage for the benefit of their daughter Juliet. In the agreement, the trustee agreed to keep the property rented and maintain the property. The trustee further agreed “to pay over all remaining rents and income in cash, into the hands of my said daughter, Juliet, in person, and not upon any written or verbal order, nor upon any assignment or transfer by the said Juliet.” The Illinois Supreme Court held it was the father’s intent that the property be provided solely for his daughter and not for the benefit of her creditors. It was the father’s property and he had the right to restrict payment solely to her.

Thus, despite that fact that Juliet had some financial issues. In the end, her father insured her inheritance was protected and that she would enjoy the future rents from that inheritance.

The right to create a spendthrift trust has been codified and can now be found at 735 ILCS 5/2-1403. In essence, Illinois law continues to give a parent the right to protect the inheritance they give their children.

However, when a trust is not carefully drafted, then the spendthrift trust protection can be lost. In a recent case, Carroll v. Takada, 864 F3d 512 (7th Cir, 2017), a creditor was able to access a child’s inheritance. In that trust, the trust was to be distributed one-third to each child. The trust had a spendthrift provision. The court acknowledged that spendthrift trust provisions are valid, but since the debtor child was to get an outright distribution that would dissolve the trust, then the spendthrift trust protection terminated. The trustee had no power to stop the distribution. The creditor and not the child got the inheritance.

When comparing the two cases, one can see that not all trusts are the same. Drafting spendthrift trust provisions often involves careful trade offs between creditor protection, administrative ease, taxes, and family dynamics.

While creating a spendthrift trust requires care. The implications are significant. You can give your loved ones assets in a manner that can protect them. As the Illinois Supreme Court put it in 1884, you can give an inheritance “effectually placed beyond the reach of unprincipled schemers and sharpers.”