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Bankruptcy's Effect on Estate Planning (Part 2)

What happens if one of my beneficiaries is in bankruptcy when I die?

· trust and estate,estate planning,will,bankruptcy,attorney

If you die within 180 days after your beneficiary files for bankruptcy, they must disclose the inheritance to the bankruptcy trustee. (11 U.S.C. § 541(a)(5)(A)) In a chapter 7 bankruptcy case, unless the property is exempt, the trustee is free to take the inheritance to pay off your beneficiary’s creditors. If the beneficiary has filed a chapter 13 bankruptcy, the value of the inheritance (except for any exempt property or money) will be added to the amount available to the beneficiary for repaying creditors under the repayment plan, i.e., it will increase the amount of the payments your beneficiary must make.


● You are free to amend your will to eliminate all gifts to a beneficiary who has filed (or may file) bankruptcy to avoid having your hard-earned money and prized belongings used to pay off creditors rather than being distributed to the beneficiary. Many people dislike this option, however, because they do not want to effectively disinherit someone (often, their child) whom they want to benefit from their estate.

● One of the best ways to prevent your life savings and property from being used to pay off a beneficiary’s creditors is to createa revocable living trust.You can transfer ownership of your money or property to the trust and retain complete control over and enjoyment of your property during your lifetime. Because the trust (and not the beneficiary) owns the property and because the beneficiary has no legal claim to the trust assets during your life because the trust can be revoked at any time prior to your death, the property will not be considered part of the beneficiary’s bankruptcy estate. 

In addition, money and property held in a trust with a valid spendthrift provision, specifying that the beneficiary cannot transfer their interest in the trust and has no control over it, typically cannot be used to pay off the beneficiary’s creditors in bankruptcy. After your death, your beneficiary can receive distributions, i.e., gifts from the trust, according to the terms of the trust, as long as they are purely at the trustee’s discretion or for certain specific purposes, such as health, education, support, andmaintenance. However, any amounts distributed prior to bankruptcy or within 180 days after the bankruptcy petition has been filed can become part of the beneficiary’s bankruptcy estate and used to pay off creditors.

● A standalone retirement trust that is drafted as an accumulation trust, rather than a conduit trust, can be used to protect the funds held in your individual retirement account (IRA) or other retirement account, such as a 401(k),from being taken by creditors if your beneficiary files for bankruptcy after your death. Because inherited IRAs, in contrast to the debtor’s IRA, are not protected in bankruptcy proceedings, it is necessary to provide additional protection by using a trust. The trust is funded from your retirement account upon your death. Because the trust is irrevocable, those funds are protected from the beneficiary’s creditors. 

We Can Help You Plan Ahead

It is impossible to know what the future holds. Those who are prospering today may encounter financial problems tomorrow. Do not wait until you or your loved ones are experiencing money troubles, or even the prospect of bankruptcy, to take action to protect the life savings, heirlooms, and property that you have worked so hard to accumulate. We can design an estate plan that will help protect your property and money—and your loved ones’ inheritances. Call us today to create or update your estate plan to ensure that your property is protected from creditors’ claims, whether or not you or a loved one ever files for bankruptcy. 

(This is not intended to be legal advice and is only informational)