There are many types of trusts, and they can be used to serve a variety of purposes: avoiding probate, minimizing taxes, protecting assets from creditors, providing for loved ones, and more. Your goal in creating a trust, and your circumstances, dictate the type of trust you should have.
If your goal is to provide for another person through a trust, but not to jeopardize their eligibility for government benefits like Medicaid or SSI, and to keep the assets in the trust safe from the beneficiary's creditors, a third-party discretionary trust might be the right option for you.
What is a third-party discretionary trust? "Third-party" refers to the fact that the trust is funded with assets that are not owned by the person who is to benefit from the trust; in other words, the asset belongs to a third party. "Discretionary" means the trustee has discretion regarding use and distribution of trust assets for the benefit of the named beneficiary or beneficiaries. A key trait of a discretionary trust is that the beneficiary does not have any legal power to compel the trustee to release any trust assets to him or her.
The fact that the beneficiary cannot require the trustee to give him or her income or assets from the trust is one of its primary advantages. (Admittedly, the beneficiary may not always feel that way.) But because the assets in the trust did not originally belong to the beneficiary, and because they are not subject to the beneficiary's control, they are generally not considered, legally, to be the beneficiary's property.
As a result, those assets, though they can and will be used for the beneficiary's benefit, are outside the reach of the beneficiary's creditors. An example: you have significant income-producing assets that you want to benefit your son Joe. Joe is married to Liz, and you have reason to fear the marriage will not last. If it falls apart, you want to protect your child's inheritance from divorce.
By creating a trust with assets that belong to you (not Joe) and giving the trustee the power to use trust assets as needed for Joe's benefit, in the trustee's sole discretion, you protect the assets in the trust from Liz's claim that they are marital property.
Likewise, if Joe had a tendency to overspend, and his creditors sued him and took judgments against him, they probably would not be able to reach the assets in the trust to satisfy the judgment. Those assets do not belong to Joe. Discretionary clauses in a trust document are sometimes also known as "spendthrift" clauses because of this protection. If you can't trust your children with your wealth, a third-party discretionary trust for their benefit might be a good choice.
Another common indication for the use of a third-party discretionary trust is for a beneficiary with special needs. Individuals with lifelong disabilities or special needs often qualify for, and need, government benefits like SSI. However, many benefits are means-tested, meaning that if an individual with income or assets above a certain amount may lose their eligibility for the benefit. Even if they can manage to "spend down" their assets, they may have to go to the back of a waiting list to actually obtain some benefits once they qualify again. A third-party discretionary trust can allow a parent, grandparent, spouse, or other relative to provide for a loved one without jeopardizing their eligibility for benefits.
One major thing to think about when considering whether to create a third-party discretionary trust: such trusts are usually irrevocable. Therefore, if you cannot afford to commit assets to the trust, don't. You won't be able to reclaim them later if you're in a financial bind and need the assets.
You should also consider whether there is a better way to achieve your goals. While assets in third-party discretionary trusts are generally not reachable by creditors of the beneficiary, there may be exceptions depending on the circumstances or the language of the trust. The best course of action is to work with an experienced estate planning attorney and make sure that your attorney thoroughly understands your goals in creating the trust. An experienced attorney will help you understand the advantages and risks of a third-party discretionary trust, and whether there are better options to serve your needs.