What Happens If One of My Beneficiaries Is in Bankruptcy When I Die?

Posted by Joseph Franks on January 17th, 2020

If you die within 180 days after your beneficiary files for bankruptcy, your beneficiary must disclose the inheritance to the bankruptcy trustee. 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 that the beneficiary has to repay creditors under the repayment plan, i.e., it will be used to increase the amount of the payments your beneficiary must make under the repayment plan. It is important to have an experience and skilled Estate Planning Lawyer to assist with all the minor and major guidance with regard to your beneficiaries.

Solutions

You are free to amend your will to revoke all gifts to a beneficiary who has filed bankruptcy (or may do so) to avoid having your hard-earned money and prized belongings used to pay off creditors rather than be distributed to the beneficiary. Alternatively, you could include a provision in the will stating that no part of your estate is to be used to benefit a creditor of any beneficiary. Many people dislike this option, however, because they do not want to effectively disinherit someone (often, a child) 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 create a revocable living trust. You can transfer ownership of the money or property to the trust and retain complete control and enjoyment over your property during your lifetime. Because the trust owns the property, not the beneficiary, and 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, it 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 his or her 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, or maintenance. However, any amounts that are distributed prior to bankruptcy or within 180 days after the bankruptcy petition is filed can become part of the beneficiary’s bankruptcy estate and used to pay off creditors.

A standalone retirement trust can be used to protect the funds held in your Individual Retirement Account (IRA) from being taken by creditors if your beneficiary files for bankruptcy after your death. Because inherited IRAs are not protected in bankruptcy proceedings like the IRA of the debtor, it is necessary to provide additional protection through the use of a trust. The trust is funded from your IRA upon your death. Because the trust is irrevocable, those funds are protected from the beneficiary’s creditors. A bonus is that the IRA assets will continue to grow tax-deferred within the trust.

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Joseph Franks

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Joseph Franks
Joined: September 16th, 2019
Articles Posted: 102

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