Bankruptcy is a reality for many individuals, especially these days. But how will filing for bankruptcy affect or be affected by your estate planning? There are two main contexts that will be considered in this post: that of you, yourself, filing for bankruptcy, and that of one of your beneficiaries filing for bankruptcy. In both situations there are ramifications that may affect your estate.

If you are facing financial difficulties, it may be necessary for you to file for bankruptcy. Before this point, you may have invested the money and effort to establish an estate plan for your family. If you established a trust, you may have already transferred property out of your individual name and into the name of your trust. Typical family trusts are revocable trusts that hold property until your death, whereupon the property is distributed according to the trust’s terms to your beneficiaries. If you have one of these trusts, you should be aware that any property that you transferred into it will be viewed as your own individual property in bankruptcy, just as if you never created the trust at all. In other words, revocable trusts will not protect your otherwise non-exempt property simply by virtue of the fact that the trust is the record owner of the property. The trust is essentially treated as invisible, and the bankruptcy proceeds as if it is not there. If you have an atypical trust, such as an irrevocable, self-settled, or A/B trust with one deceased trustor, there may be some additional considerations. You should speak to a bankruptcy attorney about your individual circumstances in those cases.

One context where the terms of your trust will make a difference is when one of your beneficiaries is the one filing the bankruptcy. Theoretically, when this happens their interest in your estate, because it is an asset of value, becomes part of the bankruptcy estate and is subject to seizure by the bankruptcy trustee. However, the bankruptcy code, 11 U.S.C. § 541(c), provides that any restrictions on the transfer of a beneficial interest of the debtor in a trust that is enforceable in non-bankruptcy law is also enforceable in a bankruptcy. In other words, if your trust contains a “spendthrift clause”, which is typical in most trusts, then the trustee cannot seize your beneficiary’s share of your estate. A spendthrift clause prevents creditors from seizing non-disbursed portions of the trust. Therefore, as you might guess, if your beneficiary has already received the funds from your trust before he files for bankruptcy, those assets can be seized. But if the trustee of your trust is aware of the financial crisis of the beneficiary, she can withhold distribution to him for a period of time, utilizing the provisions of the spendthrift clause, and prevent the bankruptcy trustee from seizing the assets.

If you are still alive when your beneficiary files for bankruptcy, there is no risk of interference with your estate unless you have set up your trust to make mandatory distributions to your beneficiaries while you are still living. But if you are elderly or expecting to experience health problems in the near future, you may want to consider amending your estate planning documents to remove the bankrupt beneficiary from being named in your estate plan at all, so as to avoid altogether the risk of any of your estate becoming part of the bankruptcy trustee’s pot of money to be given to the debtor’s creditors.

It is important to understand that a typical family trust is not going to provide your assets with any sort of bankruptcy protection in the case of your own bankruptcy. If it is written properly, it may provide protection in the case of a beneficiary’s bankruptcy, but there are strategies that may want to be used in that circumstance. An experienced bankruptcy attorney can assist you in planning for whatever lay ahead.