Question: My nephew is a beneficiary of the trust my parents set up before they died. He is asking for an early distribution from the trust so that he can pay off some significant medical bills. I am the trustee. Should I make the distribution?
Short Answer: It’s complicated.
Longer Answer: Let’s discuss the pros and cons, and what options you have.
First Job – Follow the Trust Instructions and Rules
As a trustee, you have a fiduciary duty to the individuals who are beneficiaries under the trust. You are also required to follow the rules and instructions established by the trust. Understanding those rules is key to answering this question.
Discretionary v. Mandatory Trust Distributions
Most trusts give the trustee discretion over how and/or when to make certain distributions. Mandatory distributions are those that the trustee is required to make, without regard to circumstances. Discretionary distributions require the trustee to consider specific circumstances or events, as set out in the trust document itself, and to then exercise judgment and discretion in determining what should be distributed, when the distribution should be made, or even whether the distribution should be made at all.
The instructions of the trust itself are critical in deciding when, how, or if to make discretionary distributions. A trustee is responsible to follow the terms of the trust.
Spendthrift Provisions of a Trust
Trusts will commonly contain what is sometimes referred to as a “spendthrift” provision. This part of the trust is intended to protect trust assets from a beneficiary’s creditors.
For example, a trust may provide that a beneficiary’s share is to be held in trust until such time that the beneficiary turns 25 years old, and then that it should be distributed only as the trustee determines is appropriate. Such a trust may also include provisions that prevent the beneficiary from using their interest in the trust assets as collateral for a loan or from using trust assets to satisfy creditor claims against that beneficiary.
The key is going to be making sure that, as trustee, you are following the requirements and rules established in the trust itself.
Options and Alternatives
Looking at the initial question, whether or not to make a distribution that will allow a beneficiary to pay off medical bills, the answer will depend on circumstances.
Are the bills relatively small? Are the bills so large that bankruptcy should be considered?
Often, the person who establishes a trust includes a spendthrift provision so that the trust will not be affected by a potential future bankruptcy. Making a distribution for the purpose of avoiding bankruptcy may defeat the intent of the grantor.
Consulting with an Attorney
The answer is complicated and will often depend on specific details of a given situation. Consultation with an attorney is recommended.