Can You Inherit Money After Declaring Bankruptcy?

by Tom Streissguth

    Filing for Chapter 7 bankruptcy temporarily protects you from creditors, and discharges those debts that the law allows the court to discharge. Chapter 13 allows you to repay creditors over several years, according to a repayment plan. If you expect to inherit, you need to consider some important details of the bankruptcy law. Bankruptcy does not stop your legal rights to an inheritance, but if your financial situation changes, the terms of the bankruptcy case might also change -- or your right to bankruptcy protection may end. It all depends on the type of bankruptcy case you filed, the amount of money involved -- and the timing.

    Income Guidelines

    Individuals and couples may file for Chapter 7 bankruptcy protection, in which a court-appointed trustee seizes non-exempt assets to repay creditors. In an important bankruptcy reform law passed in 2005, anyone filing for Chapter 7 must meet certain income guidelines. If your income is above the median income for your state and you can afford to pay 25 percent of your unsecured debts, then you are barred from filing Chapter 7, according to the formula passed in 2005. If your income is below the median but you still can afford to pay 25 percent of these debts, you may have to file Chapter 13, which sets out a repayment plan for your creditors over several years. In the eyes of the law, receiving an inheritance can affect this formula, your ability to pay debts and your eligibility for bankruptcy.

    Disclosure to Trustees

    A trustee is a court-appointed financial adviser or attorney who oversees the bankruptcy case. In a Chapter 7 filing, he handles your property; in a Chapter 13 filing, he handles your repayments. The federal law on bankruptcy requires that you disclose to the trustee all income you receive, including an inheritance. For bankruptcy purposes, you receive the inheritance on the day the testator dies. The testator is the person who left you the assets. If this happens within 180 days of filing a petition for bankruptcy, then the inheritance becomes a part of the bankruptcy estate. The trustee can seize the estate to repay creditors in a Chapter 7. Under Chapter 13, he may change your repayment plan, if your estate gains an inheritance.

    Exemptions

    In some cases, the inheritance may be exempt from seizure or handling by the bankruptcy trustee. If the inheritance is placed in a "spendthrift" trust, naming you as the beneficiary, the bankruptcy does not affect it, although you are free to use it to repay creditors. A spendthrift trust places restrictions on how much it pays the beneficiary every year, or has other restrictions, which are supposed to be enforced by the trustee. Once the money is paid out, however, it can be claimed by creditors if you are still in bankruptcy.

    Repayment Plans

    If you have filed under Chapter 13 reorganization and you receive an inheritance, then you must declare the inheritance to the trustee, who will adjust your repayment schedule to take account of the new funds. Unsecured creditors are paid a percentage of their principal, while priority debts, such as back taxes and federally guaranteed student loans, are paid in full. The trustee has the right to change the percentage of outstanding principal you need to repay in order to get a discharge of unsecured debts at the end of the process.

    POD Accounts, Retirement Accounts and Wildcards

    A payable on death account names a beneficiary if the account owner dies. In this event, money in the account is automatically transferred to the control of the beneficiary. Recent decisions in several important bankruptcy cases have placed POD accounts out of the reach of a bankruptcy trustee. In addition, the law allows bankruptcy filers to exempt retirement funds up to $1 million in value; wildcard exemptions allow you to protect certain assets up to a dollar limit. The exempt funds would not be considered in the Chapter 7 means test, or subject to seizure. Nor may they serve as the basis for a change in your repayment plan under Chapter 13.

    About the Author

    Tom Streissguth has authored more than 100 books for the school and library market, including works for the Gale, Enslow, Facts on File and Lerner Publications. He is the founder of The Archive, an independent publisher of historical journalism collections, and holds a Bachelor of Arts from Yale University.

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