How Do Spendthrift Trusts Affect Bankruptcy?
When people in financial distress consider bankruptcy, they often worry about what assets they'll lose and what they can keep. One question that comes up is whether a spendthrift trust—a specific type of trust designed to protect a beneficiary’s interest from creditors—will be affected by the bankruptcy process.
Spendthrift trusts are often created to protect beneficiaries from themselves. But when that beneficiary files for bankruptcy, the trust's protections may come under scrutiny. At The Orantes Law Firm in Los Angeles, California, we can help you understand how these trusts work, what protections they offer, and how courts tend to treat them in Chapter 7 or Chapter 13 cases.
What Is a Spendthrift Trust?
Before digging into how they’re treated during bankruptcy, let’s start with a basic explanation of what a spendthrift trust is. In California, this type of trust contains specific language that restricts the beneficiary’s access to the trust funds. It also prevents creditors from going after those funds before they’re distributed.
Spendthrift trusts are usually established by someone other than the beneficiary who wants to protect the beneficiary's inheritance or financial future. Once the trust is created, the trustee (not the beneficiary) has full control over the funds and makes distributions according to the terms set out in the trust document. Here are some key features of a spendthrift trust:
Limited control by the beneficiary: The person receiving the funds can't demand payments or control how or when they receive them.
Creditor protection: Creditors generally can’t touch the trust's assets until after they’re distributed.
Trustee discretion: The trustee usually has the authority to decide when and how to distribute funds.
Now that we've established what a spendthrift trust is, let’s look at how it interacts with bankruptcy in California.
Are Spendthrift Trusts Considered Bankruptcy Estate Property?
When someone files for bankruptcy, most of their assets become part of the bankruptcy estate, which the trustee can access to pay off creditors. Whether a spendthrift trust becomes part of that estate depends on how the trust is written and how it's being used.
California follows both federal bankruptcy law and state trust law, and these laws can intersect in complicated ways when it comes to trust assets. The key question is whether the debtor (the person filing for bankruptcy) has a "legal or equitable interest" in the trust property. Here’s how bankruptcy law views trust interests:
Fully discretionary interests: If the trustee has complete control and the beneficiary has no guaranteed right to distributions, the interest is usually not included in the bankruptcy estate.
Mandatory distributions: If the trust requires the trustee to make regular payments, those payments may be counted as income and could be available to creditors.
Revocable trusts: If the debtor created the trust and retained control, the trust is generally included in the estate.
A properly drafted spendthrift trust—where the beneficiary has no control and no enforceable right to demand payments—may be protected. But if the trust language allows the beneficiary too much control or guarantees regular payments, it might be fair game.
When Spendthrift Trusts Are Protected in Bankruptcy
In many cases, spendthrift trusts do provide real protection during bankruptcy. This is especially true when the trust is clearly created by someone other than the debtor, includes strong spendthrift provisions, and gives the trustee complete discretion over distributions. Here are a few signs that a spendthrift trust might be protected:
The debtor didn’t create the trust: Bankruptcy courts are much more likely to respect a trust created by someone else.
The trust includes a clear spendthrift clause: Courts look for explicit language that limits both the beneficiary’s and creditors’ access.
The trustee controls distributions: If the trustee can deny or delay payments, the court usually won’t count the trust as part of the bankruptcy estate.
No regular income from the trust: If the debtor isn’t receiving consistent payments, the trust is less likely to be considered income-producing property.
If these factors apply, the trust’s assets may be safe from creditors, including the bankruptcy trustee.
When Spendthrift Trusts Might Be Vulnerable
Not all spendthrift trusts are bulletproof. Some trust provisions—or the way the trust is used—can make it easier for bankruptcy courts to pull trust assets into the estate. In these situations, a debtor may find that funds they assumed were protected are suddenly at risk. Here are some factors that weaken spendthrift protection:
The debtor created the trust: Self-settled trusts are generally not protected, even if they include a spendthrift clause.
Regular mandatory distributions: If the trust requires specific payments at set intervals, those payments may be accessible.
Control over trust assets: If the debtor acts as both trustee and beneficiary, or can influence how the trust operates, that control can be enough to include it in the bankruptcy estate.
Broad trust language: Vague or overly flexible wording can give the court grounds to treat the trust as an accessible asset.
If a trustee consistently makes payments that resemble income, the bankruptcy court might treat them as such, especially in a Chapter 13 case where disposable income matters for repayment plans.
How Chapter 7 and Chapter 13 Bankruptcy Treat Spendthrift Trusts
Spendthrift trusts aren’t treated the same in every type of bankruptcy. Chapter 7 and Chapter 13 handle income and assets differently, which means a trust that’s safe in one chapter could be a problem in another.
Chapter 7 bankruptcy and spendthrift trusts:
Asset focus: Chapter 7 looks at what you own, not what you earn.
Protected if structured properly: A spendthrift trust is more likely to be excluded from the estate.
Mandatory payments may still count: If the trust pays regularly, those payments might be claimed by the trustee up to a certain point.
Chapter 13 bankruptcy and spendthrift trusts:
Income focus: Chapter 13 is based on your ability to make monthly payments to creditors.
Regular trust distributions count as income: Even if the trust itself is protected, the income from it could increase your required monthly plan payments.
The court may consider future distributions: Judges sometimes consider expected trust income when evaluating a proposed repayment plan.
In short, the way the trust operates—and the chapter of bankruptcy you choose—can affect how much protection you actually have.
What California Law Says About Spendthrift Trusts
California recognizes spendthrift provisions as valid and generally supports the idea that beneficiaries shouldn’t be able to assign or pledge their interest in a trust. Under California Probate Code §§ 15300–15301, a creditor can’t reach a beneficiary’s interest in a trust that includes a valid spendthrift clause—until distributions are made.
That said, California courts can still reach trust assets in some limited situations. For example, if a debtor owes child support or spousal support, a court may allow access to otherwise protected trust income. Similarly, if a debtor files a fraudulent transfer, \courts can undo those transfers. Here’s California’s position on trust protection:
Spendthrift clauses are generally upheld: Courts look for clear, strong language.
Distributions can be reached once made: Once the trustee distributes funds, they become fair game.
Special exceptions apply: Family support obligations and fraudulent behavior can override trust protections.
So even with California's strong trust laws, protection isn’t absolute.
How Bankruptcy Trustees Analyze Spendthrift Trusts
When a debtor lists a spendthrift trust in their bankruptcy schedules, the trustee will review the trust documents carefully. Trustees are looking for opportunities to increase the value of the estate and pay creditors more. That means they’ll try to determine whether the trust’s protections are legitimate. Here’s what trustees look for in trust documents:
Who created the trust: Self-created trusts are more vulnerable.
Type of beneficiary interest: Is it discretionary or mandatory?
Distributions made before bankruptcy: Past trust payments might suggest future income.
Any control by the debtor: If the debtor can influence the trustee or distributions, the protection weakens.
Being honest and upfront about trust interests is critical. Hiding or failing to disclose a spendthrift trust can lead to serious consequences, including dismissal of the bankruptcy or even allegations of fraud.
Planning Ahead With a Spendthrift Trust
If you’re considering bankruptcy and know you're a beneficiary of a spendthrift trust, you should speak with a knowledgeable bankruptcy attorney early in the process. Some planning may help reduce risk, especially if you’re receiving regular trust distributions. Here are some steps that may help protect your interests:
Gather all trust documents: Your attorney needs the full trust agreement, not just a summary.
Understand how distributions are made: Is the trustee truly in control, or is there a set schedule?
Avoid altering the trust: Making changes to the trust shortly before filing could raise red flags.
Don’t attempt to hide the trust: Full disclosure helps avoid legal trouble and builds trust with the court.
Good legal advice can make a significant difference in how your trust interests are treated.
Contact Us Today
Spendthrift trusts can provide meaningful protection in bankruptcy, but that protection isn’t absolute. A skilled bankruptcy attorney at The Orantes Law Firm can help you sort through the details. We serve clients in Orange County, Woodland Hills, and Los Angeles, California. Give us a call today to get started with a free consultation.