As wealth preservation for future generations has become a popular topic among clients, estate planning practitioners have changed their tune when advising clients on how distributions should be made to beneficiaries. Traditionally, many clients chose to have their beneficiaries receive their inheritance in stages, i.e. one-third at age 25, one-half at age 30 and the balance at age 35. However, if a beneficiary has an outstanding creditor, the mandatory distributions at specified ages may serve only to pay the debts of the beneficiary. A recent bankruptcy court case (In Re: Castellano) is the perfect example of why an individual should consider keeping assets in trust for his or her beneficiaries.
The United States Bankruptcy Court’s ruling in In Re: Castellano, 2014 WL 3881338 (Bankr. N.D. Ill. Aug. 6, 2014), highlights an important issue when thinking about one’s estate plan – wealth preservation for future generations. In In Re: Castellano, the debtor was the beneficiary under a trust established by her mother. The terms of the trust provided that upon the Settlor’s death, the trust assets would be divided equally among the Settlor’s four children, one of whom was the debtor. The Trust, however, also contained a clause (commonly referred to as a “spendthrift clause”) which stated that if, by reason of bankruptcy or insolvency, “all or any part of the income or principal of the Trust might fail to be enjoyed by a beneficiary or might vest in or be enjoyed by some other person, then the interest of that beneficiary shall immediately terminate.” The Trustee was granted the discretion to invoke this provision and make distributions, in his or her sole discretion, for the beneficiary’s education and support.
During the administration of the Settlor’s estate, the debtor sent a letter to the Trustee advising that she was filing for bankruptcy and stated that it was the Trustee’s obligation to invoke the spendthrift provision. The Trustee agreed and held the debtor’s share in trust as opposed to making the outright distribution. The Bankruptcy Court held that the debtor effectively transferred the assets into a self-settled trust in an attempt to shield the debtor’s assets from creditors. As a result, the Bankruptcy Court brought the trust assets into the debtor’s bankruptcy estate, thereby effectively wiping out most, if not all, of the debtor’s inheritance.
In In Re: Castellano, the result would likely have been different if the Trust required the assets to stay in trust subject to discretionary distributions of the Trustee. Individuals whose estate plan includes mandatory distributions to descendants at specified ages may want to revisit their estate plan in light of the holding in In Re: Castellano.