If you learn you're the beneficiary of a trust soon after you file for bankruptcy protection, it may be too late to protect your inheritance. Your bankruptcy trustee can, and probably will, direct you to relinquish your share of trust assets to your creditors to pay off some or all of your debts. It’s not a hopeless situation, however. If you act before you inherit and before you file, you might still benefit from the trust.
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Speak with the creator or grantor of the trust, the individual who has named you as a beneficiary. If it’s a revocable trust, he can continue to make changes to it during his lifetime. Ask him to add a spendthrift clause to your beneficiary designation and expected inheritance. Section 541(c)(2) of the United States Bankruptcy Code prevents your trust assets from going to a third party, such as a bankruptcy trustee or your creditors, when this clause is included in the trust documents.
Disclaim your inheritance. This won’t help you benefit from the trust assets personally, but it will protect the grantor’s wealth from going to your creditors. Other beneficiaries can still benefit from the proceeds when the grantor dies. The effectiveness of this action depends on disclaiming before you file for bankruptcy, however. If you do it after you file, the court might construe it as fraud.
Use the wild card exemption available to you under bankruptcy law to remove your trust assets from your bankrupt estate. Both the United States Bankruptcy Code and individual state bankruptcy laws allow debtors to exempt property up to a certain dollar amount. Your bankruptcy trustee cannot claim these protected assets to satisfy your debts. The federal exemption amount is $11,200 at the time of publication. State exemptions are usually less. You can’t use both the state and federal exemption, but if your trust assets are valued at $11,200 or less, you can still benefit from them regardless of the fact that you’ve filed for bankruptcy protection.
Tips & Warnings
Even if you take no precautions, your trust inheritance might still be safe from your bankruptcy proceedings, depending on when the grantor dies. If you file for Chapter 7 protection, your inheritance is only vulnerable for 180 days, or six months, from the date you file your bankruptcy petition. After that time, your creditors have no claim to it. If you file for Chapter 13 protection, however, this involves proposing a plan to the court to repay your debts rather than erase or discharge them. In this case, your bankruptcy trustee can require you to use your inheritance to repay your creditors as part of your plan. This is often true even after the 180 days has passed.
References & Resources
- Bankruptcy Law Network: Spendthrift Trusts in Bankruptcy –It’s a Question of State Law
- National Bankruptcy Forum: What if I File Chapter 7 Bankruptcy and I’m Named as a Beneficiary in my Parents Trust?
- Trusts and Estates: Protect Trust Assets in Bankruptcy
- Bankruptcy Law Network: What Happens if I Inherit Property While I’m in Bankruptcy?
- The Free Dictionary: Spendthrift Clause
- Comstock Images/Comstock/Getty Images