What is a Spendthrift Clause in a Life Insurance Policy?
Let’s start with defining a Spendthrift Trust
A “spendthrift trust” is a form of trust meant to protect the heir of an estate from creditors. A trust is created when an individual puts money aside to be managed, invested, and distributed by a trustee. Often, an asset management company (AMC) serves as trustee. Trusts vary in the amount of discretion that they afford to the trustee. Some trusts specify that the trustee can distribute funds “as needed,” while others specify restricted uses or amounts at specific time intervals. In contrast to a typical trust, in which the trustee receives some level of discretion over when to use/withdraw funds, spendthrift trusts typically restrict distribution of the trust to regular installments. For instance, if the trust value were $2,000,000, the trust might be paid out over the course of 10 years through annual, $200,000 installments.
Consequently, creditors and debt collection agencies cannot come after the full value of the trust. If the beneficiary only has the latest $200,000 payment in his or her account, the creditor is unable to reach the other $1,800,000 of assets, as they still technically belong to the AMC/trust and are not at the discretion of the beneficiary/heir. Creditors can access the funds to the same extent that the beneficiary can.
Some states allow for the creation of “Domestic Asset Protection Trusts,” which are self-serving spendthrift trusts that protect the creator’s assets from creditors. These function in much the same manner as other spendthrift trusts, except that payments are made back to the original creator instead of a beneficiary. As of 2017, DAPT trusts are only permissible in sixteen states as the concept is still relatively new.
It is important to note that since life insurance payments go to a beneficiary after the policyholder’s death, the policyholder cannot access his or her own death benefit. Consequently, life insurance is not used as a form of DAPT.
Spendthrift Clause: how spendthrift trusts relate to life insurance
Life insurance policies are treated in much the same manner as trust funds; both function as assets accumulated over the course of the creator’s (or policyholder’s) life. Likewise, a “spendthrift provision” or spendthrift clause is a clause in a life insurance policy which safeguards the beneficiary’s death benefit from creditors.
In life insurance policies with spendthrift provisions, the death benefit assets technically belong to the insurance company, which acts as an AMC. Since the insurer (not the beneficiary) owns the total benefit, its cumulative value is not subject to the beneficiary’s outstanding debts. As with a spendthrift trust, spendthrift life insurance policies pay out benefits over a given period (e.g. five years) on a regular basis, as opposed to singular lump sum.
Life insurance companies profit from spendthrift provisions because they can access money for more time. If a life insurance company is wrongfully limiting or restricting your benefits, be sure to contact an experienced life insurance lawyer to evaluate your case.