The Relationship Between Bankruptcy, Inheritances, and Estate Planning

If you are considering filing for bankruptcy, there are a few things you should know about how it might impact a prospective inheritance as well as your estate plan. Bankruptcy can sometimes affect the process of distributing an estate after someone dies, and it may also impact how much money heirs receive as an inheritance. Understanding these potential impacts can help you make more informed decisions about whether or not to file for bankruptcy and how to plan ahead.

Bankruptcy Basics

Bankruptcy is a legal process that helps people who can’t pay their debts get a fresh start. The right to file for bankruptcy is provided by federal law, and all bankruptcy cases are handled in federal court. There are several different types of bankruptcy, but the two most common for consumers are Chapter 7 and Chapter 13.

In a Chapter 7 bankruptcy, most of the debtor’s non-exempt assets are liquidated to pay creditors. In a Chapter 13 bankruptcy, the debtor reorganizes their obligations and enters into a repayment plan. Bankruptcy can be an effective way to get out of debt, but it’s important to understand the pros and cons before filing and to work with an experienced estate planning lawyer if you think your estate plan might be affected.

How Bankruptcy Could Impact Your Estate Plan

For many people, an estate plan is a way to ensure that their assets are protected and distributed according to their wishes. However, if you file for bankruptcy, your estate plan may be impacted in ways that you didn’t anticipate.

One of the most common ways that bankruptcy can affect your estate plan is by putting your assets at risk. If you have significant equity in a particular non-exempt asset, it may be subject to seizure in order to satisfy your creditors. In addition, certain types of trusts can be dissolved in bankruptcy proceedings, which could change how your assets are distributed.

More complications may occur if unexpected events happen during your bankruptcy filing. For instance, if you pass away while a Chapter 7 bankruptcy filing is pending, your creditors will be repaid through the liquidation of your assets. Only the remaining assets, known as the residue of your estate, will be available for your beneficiaries’ inheritances.

If the same circumstance occurs but you filed for Chapter 13 bankruptcy instead, the result is a bit less certain. The possible options will be up to the judge’s discretion and may include:

• Case dismissal
• Hardship discharge
• Converting to a Chapter 7 case
• Continuing to make Chapter 13 payments as normal using the deceased’s assets

How Bankruptcy Could Impact Inheritance

The bankruptcy of beneficiaries can also affect inheritances. If an heir receives an inheritance during a pending bankruptcy proceeding, it may be at risk of seizure by creditors.

Here is how this can happen: A bankruptcy filing results in the creation of a bankruptcy estate, which has temporary legal ownership over the assets of the debtor during the bankruptcy proceedings and is administered by a bankruptcy trustee. This ownership includes assets the debtor acquires during the proceedings. As a result, the bankruptcy estate will have ownership of any money or property inherited by the debtor during this period.

Exactly how this plays out depends on the type of bankruptcy being filed. In Chapter 7 cases, inherited assets are typically included in the assets used to repay the debtor’s creditors, and the total value of the inheritance is subtracted from the total debt.

The time that has elapsed since the bankruptcy filing also plays a role in the outcome. For instance, in Chapter 7 bankruptcy cases, inheritances only go toward the bankruptcy estate if the inheritance is received during the first 180 days following the bankruptcy filing. Anything received after 180 days is considered the debtor’s property. In these instances, the clock begins to tick on the day the decedent passed away.

The time elapsed does not matter as much in Chapter 13 cases because the judge can consider the inheritance as an asset when determining the income available for the repayment plan.

Each of these possible scenarios can be daunting to consider, but with proper planning and strategy, you don’t need to let bankruptcy prevent you or your loved ones from enjoying the full benefit of your hard-earned wealth. Contact a trusted New Jersey estate planning lawyer at The Knee Law Firm by calling 201-996-1200.