Protective Trusts

How a Protective Trust can work for your beneficiaries

Protective trusts (or spendthrift trusts, as they are sometimes known) share the characteristics of a life interest trust and a discretionary trust.  One of the reasons why these trusts were established was to protect beneficiaries from their own extravagance, financial indiscretions, etc.

For example if you were to make an absolute gift of your estate in equal shares to your children and one, a son say, was to become bankrupt, all his property (with few exceptions) automatically passes to his trustee in bankruptcy.  The trustee in bankruptcy is then charged with the task of collecting all of the son’s property and sharing it equally between his creditors.   However, instead of simply gifting the “family wealth” to the son you could create a trust in favour of the son for life.  In these circumstances, as the son only has a life interest, the capital has been protected.  All that can pass to the trustee in bankruptcy, in the event of the son’s bankruptcy, is his share of the trust fund, i.e. the income.

However, if you wish to try and protect the income, not just the capital of the trust in the event of a beneficiary’s bankruptcy then the solution is a Protective Trust.

A Protective Trust involves the creation of a life interest in favour of the son (in the above example), with the remainder to other children/beneficiaries on his death.  The interest is, however, determinable (and therefore comes to an early end) upon a certain event occurring: usually the son’s bankruptcy or attempted alienation (such as sale, transfer, mortgage or gift).  After determination of the life interest, the trust income is held on discretionary trusts for a class of persons which may include the son and his spouse and family.  Because it is held on a discretionary trust it is at the trustees’ discretion who has access to income and capital and it is this discretion that protects the capital and income from the creditors.  Upon the son’s death other beneficiaries (or default trust) will take the capital.