Bankruptcy’s Effect on Estate Planning
Bankruptcy may be one of the last things on your mind when you are creating an estate plan. Fortunately, the number of bankruptcy filings has declined over the past several years, but there were still 544,463 bankruptcy filings in 2020. What happens to your estate if you file for bankruptcy protection but die while still in bankruptcy? None of us knows what the future holds, so you should consider this important issue in your estate plan, even if the possibility of bankruptcy seems far-fetched right now.
What happens to my estate if I am in bankruptcy when I die?
A will enables you to leave specific instructions about whom you would like to receive your money and property and how you would like for it to be distributed when you die. However, in general, your debts must be paid before your beneficiaries can receive a dime. As a result, if you are in bankruptcy when you pass away, your beneficiaries will receive only what is left of your life savings and property when the bankruptcy case concludes.
Individual debtors typically file for chapter 7 (liquidation) or chapter 13 (repayment plan) bankruptcy. If you pass away during a chapter 7 bankruptcy, the bankruptcy case will proceed without much of an interruption because your direct participation is very limited after the meeting of creditors. The bankruptcy trustee will sell your property to obtain cash to pay off your creditors. However, certain property, such as motor vehicles, clothing, household goods, and retirement savings accounts, is exempt because it is necessary for living and working. When the bankruptcy case concludes, any remaining money or property can go through the probate process and be transferred to the beneficiaries named in your will.
A chapter 13 bankruptcy involves a repayment plan that typically lasts from three to five years, so you, as the debtor, must actively participate in the plan by making the payments. If you are in the midst of a chapter 13 bankruptcy when you pass away, your bankruptcy trustee and your survivors usually must petition the court for instructions about what to do next. Typically, there are several possible courses of action. Although the bankruptcy trustee and the survivors can request a certain course of action, the court will ultimately decide what is in the best interest of all the parties involved.
If you want to protect your savings and property against potential future creditors, consider transferring them to an irrevocable trust. You will not be able to easily amend or cancel the trust, but because you no longer own any of the property or money in the trust and have no right to change its terms, the accounts and property in the trust generally cannot be used to pay off creditors, even if you file for bankruptcy in the future.
As a result, your money and property will remain available for future distribution to your beneficiaries. But beware that this strategy will not work if you knowingly transfer money and property to avoid debt. It is important to implement this strategy proactively, long before any financial problems leading to bankruptcy arise, because you must disclose to the bankruptcy trustee any transfers made within two years before filing, and the trustee will review the transfer to evaluate whether it should be undone, making that property or money available to your creditors.
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.