Discretionary trusts are a special type of irrevocable trust that gives the trustee sole discretion over distributions (payouts) to beneficiaries. Because the beneficiary has no legal right to the money held in the trust, creditors cannot demand that the beneficiary use the funds to pay off debts.
Because of the protections they offer, discretionary trusts are a common choice for families and individuals who want to ensure that the assets they put into trust go only to the beneficiary — not the people to whom those beneficiaries might owe money.
On the other hand, discretionary trusts can be complex to set up. Being irrevocable, they require plenty of planning and forethought since they cannot be changed once funded.
Furthermore, they do not protect from all forms of creditor claims or financial recovery actions, especially when a court order is involved.
Learn about the pros, cons, and major benefits of forming a discretionary trust when you reach out to an experienced New Mexico discretionary trust lawyer. They can help you understand all the options you have, compare them to your goals for the future, and decide on the best financial and legal instruments for your specific situation.
To schedule a consultation at New Mexico Financial & Family Law with no obligation, call 505-503-1637 or contact us online today.
Trust formation involves transferring assets into the legal ownership of a new entity, known as a trust. This trust retains many of the same legal rights as an individual. That means that once assets enter the trust, a claim must be made against the trust itself in order to access them.
However, if a beneficiary has the legal right to access funds at any time, an argument can be made that the beneficiary legally owns their share of the trust. In order to close this loophole, a discretionary trust leaves asset distributions at the sole discretion of the trustee.
That distinction makes it clearer that the assets are wholly owned by the trust — not anyone else.
In order to create a discretionary trust, you will need to make a number of important decisions, such as:
Working with a New Mexico discretionary trust lawyer can help you weigh all of your options in light of your total financial portfolio. When you come to New Mexico Financial & Family Law, we’ll perform an analysis of your current portfolio and ask detailed questions about your goals for the future.
Depending on your intentions to reduce taxes, shield assets from creditor claims, provide for your beneficiaries, and hedge against common risks or uncertainties, we’ll recommend a comprehensive strategy to help you achieve all of your goals at once.
Using our legal knowledge and experience, we can then help you craft a one-of-a-kind trust or estate planning vehicle with your unique financial situation in mind. Our services reduce the risk of unintended consequences, giving you confidence that your ideal future outcomes can be reached once the trust is formed and set in motion.
Without detailed planning and consideration, you run the risk of having your assets used in ways that you did not intend. Worse, if you formed an irrevocable trust, you will have no way to alter the trust arrangements once they have been set in place.
For all of these reasons, it is highly recommended to work with an experienced discretionary trust formation team in New Mexico. They will help you carefully organize your trust, word instructions in ways that can be clearly interpreted, and anticipate possible challenges or risks, building security into your financial strategy from moment one.
With the right amount of work, you’ll have a trust in place that you can make you feel both proud of and secure in your decisions. After all, when it comes to your legacy, you really only get one chance to make it right.
A discretionary trust involves three main parties:
In many cases, distributions are given to beneficiaries according to a set of explicit instructions that the trustee must obey. However, in a discretionary trust, the trustee has sole discretion over how to manage the trust, including whether/when to make distributions to the beneficiary and how much to give them.
The grantor can leave recommendations for how these distributions will take place. For example, they can instruct the trustee to release a set amount of funds twice a year.
Alternatively, they can request that the trustee makes a distribution under certain circumstances, such as when the beneficiary graduates from a four-year college.
These recommendations are called a “standard of distribution.” The trustee has sole legal discretion to ignore them, for whatever reason, because the management of the trust is entirely up to them.
Normally, instructions for managing the trust are binding. If they aren’t followed, a beneficiary (or other party with an established interest) can sue the trustee for committing a breach of fiduciary duty.
With a discretionary trust, the beneficiary does not hold this right. However, as we will describe in greater detail later, a creditor or other interested party may be able to compel a transfer by claiming that the failure to follow a standard of distribution was done purely in the beneficiary’s interest.
In many cases, forming a discretionary trust can completely prevent creditors from accessing the funds held within it. This capability is important when the beneficiary owes money to creditors and alleges that they don’t have the available funds or assets to cover their debt.
Normally, a creditor can force the beneficiary to access the funds designated for them in order to help repay what they owe. Other times, the creditor can legally compel the trustee to make a distribution from the trust to the beneficiary, making the money available for them to claim.
With a discretionary trust, the trustee can maintain the legal position that the assets are owned solely by the trust. Since the assets are not subject to the claims of anyone else, a creditor has no legal standing to access them in any way.
Discretionary trusts have many similar concepts to a trust with a spendthrift clause, otherwise known as a spendthrift trust.
A spendthrift clause basically forces beneficiaries to obey the terms of the trust’s distribution plan. For example, if the trust only pays a certain amount each year, the beneficiary cannot force the trustee to give them more money than the designated amount.
Or, if the trust requires that the money distributed only go to certain expenses, such as college tuition, the spendthrift clause prevents the beneficiary from accessing the money for any other reason.
In some cases, you can even instruct a trustee to give the beneficiary only a specific amount on a contingent basis, such as giving them only enough to keep up with reasonable living expenses, with consideration for their current level of income.
Another important component of a spendthrift clause is that it legally bars the beneficiary from being able to transfer their interest in the trust to another party. For example, the beneficiary cannot use their interest as part of a deal to purchase a home, which would effectively be transferring payments from themselves to the party that owns the property.
The beneficiary also cannot promise the distributions to a creditor in order to satisfy their debt.
Spendthrift trusts can be both revocable and irrevocable. In other words, the grantor may have the option to change the trust or retrieve the assets contained within it under specific circumstances if the trust is revocable.
A revocable trust can make assets subject to creditor claims against the grantor; however, the decision on how to structure the trust must be made carefully with these considerations in mind. A New Mexico spendthrift trust lawyer can help you navigate these complexities.
Spendthrift clauses can prevent many common cases of abuse of trust-based income for beneficiaries while also partially shielding assets from creditors. However, creditors may be able to obtain a judgment on their behalf, legally forcing the trust to pay the creditor for debts owed.
This scenario is especially common when the creditor can prove that the funds provided through the trust are not needed to support basic, reasonable living expenses for the beneficiary.
A discretionary trust goes a step further than a spendthrift clause by making distribution recommendations totally optional. Now, not only can the beneficiary not access the money if certain circumstances aren’t met, but the trustee can flat-out refuse to pay the money without having to provide a legal reason.
In these situations, the trustee can also make decisions that go beyond the scope of the standards of distribution set by the trust. For example, the trustee can decide to distribute money intended for the beneficiary directly to the beneficiary’s creditors, their landlord, their higher education institution, medical providers, or so forth.
Finally, unlike a spendthrift trust, a discretionary trust must be irrevocable. This status makes it clear that only the trustee has control over the assets, not anyone else.
Under New Mexico law (N.M. Stat. § 46A-5-504), a trustee must follow all written standards of distribution when it comes to providing funds needed to pay for child support and/or spousal support, including support of a former spouse. In addition, the trustee must find a way to make funds available for distribution if they abused their discretion (in the opinion of the court) and if the funds would have otherwise been available if not for their abuse of discretion.
Furthermore, if a claim is made against a trustee who has access to the funds of a trust in the same capacity as a beneficiary would, a judgment could be made to force the trustee to transfer funds to themself if that transfer follows a written standard of distribution.
A beneficiary can also obtain a judgment compelling a trustee to follow a standard of distribution or to remand money for any actions seen as an abuse of discretion.
Notably, in all other situations, a trustee is not forced to make any distributions at all, regardless of whether or not the trust has a spendthrift clause and whether the trustee has abused their discretion.
Put more plainly, a trustee can only be forced to pay a beneficiary if:
Creating a discretionary trust can be complicated and expensive, but the ultimate results can be very well worth it when they help you achieve your goals — without the risk of creditors undermining your efforts. While discretionary trusts put a lot of power in the hands of the trustee, they also give your plans the best chance of avoiding the unpredictable nature of debt, the economy, and your beneficiaries’ ability to stay financially solvent.
Come to New Mexico Financial & Family Law for help with forming a trust or any other type of financial instrument you need in order to make your goals a reality. Our seasoned New Mexico trust lawyers are eager to hear from you and to help you start planning for the days ahead.
Make the call that can be the first step in a bright future for your loved ones and your legacy. Call us today at 505-503-1637 or contact us online to schedule a no-obligation case review with an experienced New Mexico discretionary trust attorney near you.
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