How Does Bankruptcy Typically Impact An Inheritance?

There are two ways bankruptcy can affect an inheritance. One would is if the deceased was in the process of filing a bankruptcy. The second is if one of the beneficiaries is in bankruptcy or had a recent bankruptcy. If the deceased was in the process of a chapter 7 bankruptcy, if bankruptcy had been filed but the discharge judgment had not yet been entered, it probably would just continue on. It’s really the same process as the estate distribution process. One significant difference is that some of the exempt assets may no longer be exempt, once the person is deceased. One would probably have to go to the bankruptcy court and appear before the judge to distribute those exempt assets through the estate.

If it’s a Chapter 13 bankruptcy, it’s much more complicated because the idea of chapter 13 is that the debtor will pay off those debts over time. Now that the debtor is deceased, there probably are not going to be any future earnings. If there are estate assets that generate income, even after the debtor dies, and that income is sufficient to meet the obligations of the Chapter 13 bankruptcy, then it may be able to continue through the three to five-year process that those take. After that process is finished, the probate estate would be able to close and distribute the remainder to the beneficiaries.

If it’s the beneficiary who is in bankruptcy, the question becomes whether that beneficiary’s inheritance is subject to the bankruptcy trustee’s right to liquidate assets and pay creditors. When one files a Chapter 7, they turn over all of their non-exempt assets to the bankruptcy trustee. The trustee then liquidates those non-exempt assets, pays the creditors proportionally, and the remainder of the debt is discharged. If, at any time within 180 days after filing for the bankruptcy, the debtor is entitled to an inheritance, that inheritance becomes part of their bankruptcy estate, which must be turned over to the trustee.

The way being entitled to an inheritance is defined is when the person you are going to inherit from dies, not when distribution is being made. If 30 days after filing bankruptcy, the debtor’s mother dies and leaves an inheritance to the debtor, even if that inheritance is not distributed for a year or two, it still must go to the bankruptcy trustee. If the debtor is entitled to the inheritance of someone who died before the bankruptcy was filed and the debtor didn’t list that inheritance on their schedule of assets, then they must go back and revise that schedule of assets, once they have some expectation of what they will receive and how much. If the debtor in bankruptcy was in a Chapter 13 bankruptcy, they may have to go in and redo the entire Chapter 13 plan, based on the increased assets.

How Can I Properly Plan My Estate To Protect My Assets By Bankruptcy Filed By My Heirs?

There are very few ways to protect your estate from your own debt when you die. We don’t want people to be able to do that. We want people to pay their debts if they are able to do so. Whether we want the deceased person’s assets to be used to pay someone else’s debt, however, is a very different question. If a person has a beneficiary who has a lot of debt, they may choose to structure that beneficiary’s distribution in such a way that it will not be subject to repayment of their debt. If the beneficiary is receiving government assistance because of some medical disability or because of their financial situation, then we can have their distribution placed into what’s called a special needs trust.

A special needs trust is a trust which is specifically designed to be able to hold assets for a beneficiary and use those assets for things that would benefit that beneficiary, but would not be paid for by their public benefits. It would not include food, shelter, or cash to the beneficiary. It could be used to pay for medical expenses that aren’t covered by Medicare or for entertainment, furniture, travel, or anything that would enhance the beneficiary’s life but not be covered by their benefits. These are very restrictive trusts but are very useful, if you have someone who is receiving a needs-based government benefit.

We could put the funds into what is known as a discretionary trust, where the beneficiary never receives control over the money. Someone else is named as a trustee to control the money for the benefit of the beneficiary and is given some discretion as to when to distribute, and how much to distribute. There is a range of how much discretion a person can be given. In general, the more protection we want to give, the more restrictive we make the trust, so we can have what is known as an ascertainable standard, where the funds can only be used for the health, education, support, and maintenance of the beneficiary. We can also have a broader standard, where the funds can be used for the beneficiary’s comfort, welfare, or happiness. We always put a restriction in that the funds cannot be distributed to a creditor of the beneficiary. If the beneficiary has outstanding debts, the funds cannot be used to pay those outstanding debts and the beneficiary can never be in control of the funds.

Alternatively, we could put the funds in an annuity trust, where the trust would be set up to pay out over a fixed period of time, over the beneficiary’s lifetime, or set up to pay out just the income of the trust over time. This protects the remaining principle of the trust. The beneficiary’s creditors would only be able to attack any resources after they are paid out to the beneficiary and the principle of the trust would remain protected. On any of these types of trusts to protect beneficiaries, a very important consideration is who is named as the trustee.

This trustee will have to serve for a very long time, potentially for the lifetime of the beneficiary, and has a tremendous obligation to manage and maintain the funds, account for the funds, file tax returns, and only make appropriate distributions. It’s a very complicated task to be this trustee. If one is going to set up a trust like this, it’s very important to find a good trustee. It is unusual that there would be a family member who would be well suited for this. More often, professional trustees will be used in these situations.

For more information on Impact Of Bankruptcy On An Inheritance, a free assessment is your next best step. Get the information and legal answers you are seeking by calling (626) 385-6303 today.

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