Gifting can always be done through a Last Will and Testament; however, many people choose to use a trust agreement instead of, or in addition to, a Will to make gifts within their estate plan. There are numerous benefits to using a trust to distribute assets, including the ability to retain a certain degree of control over the assets gifted and the ability to prevent a beneficiary from squandering assets. Once you create a trust and name a beneficiary though, can that beneficiary sell his/her interest in the trust? A Living Trust lawyer at the Collins Law Firm explains the right of a beneficiary to sell or encumber his/her interest in a living 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.
Can a Beneficiary Sell or Encumber His/Her Interest?
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. In the State of California, the California Probate Code governs spendthrift clauses, making them valid with respect to trust income and principal. A spendthrift clause only protects assets prior to distribution. Once distributed, trust assets are fair game for creditors and may be sold by the beneficiary.
Contact The Collins Law Group
For more information, please join us for an upcoming FREE seminar. If you have additional questions about living trusts and the rights of beneficiaries, consult with one of our Estate Planning Attorneys. Contact the Collins Law Firm by calling (310) 677-9787 or online at collinslawgroup.com to register for one of our FREE estate planning workshops.
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