How Does My Potential Inheritance in a Will or Trust Affect My Bankruptcy Case?

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Are you listed as a beneficiary in a will or trust?  If so, will it be an issue when you are filing for bankruptcy?  You are not entitled to anything because your loved one is still alive and well.  Most potential clients believe this is not an issue that needs to be addressed when filing bankruptcy, but leaving out a potential inheritance (which is a “contingent interest”) in a bankruptcy petition could be a huge mistake.  Most bankruptcy lawyers have a question on their intake form asking if you are named in any wills or trusts as a beneficiary.

A contingent interest in a will or trust on the filing date of your bankruptcy petition is considered to be part of your bankruptcy estate.  This means if within 180 days of the filing of your bankruptcy petition your loved one passes away and leaves you an inheritance, the contingent interest becomes a vested interest.  Whatever you are entitled to in the will or trust will be counted as an asset in your bankruptcy case and part of the bankruptcy estate.  If this interest cannot be adequately protected because you do not have enough exemptions to cover the amount of the inheritance, then the unprotected portion of the inheritance may be subject to creditor’s claims.  If you have a 90 year old grandmother who is leaving your $5 million in her will or trust and you are thinking about filing bankruptcy, you should seek the counsel of an experienced bankruptcy lawyer to discuss timing and options.

Spendthrift Trust

Spendthrift trust provisions are sometimes included in a trust document to prevent a creditor from going after a beneficiary for the entire inheritance.  Spendthrift trust provisions are allowed under California law but there are certain restrictions.  Under California Probate Code Section 15306.5, “a creditor may obtain an order directing the trustee to satisfy all or part of the judgment out of the payment to which the beneficiary is entitled under the trust instrument…as long as it does not exceed 25% of the payment that would otherwise be made to the beneficiary.”  This means that 75% of your interest is protected with 25% potentially going to your creditors.

Necessary for Support

Although creditors could potentially go after a beneficiary’s interest in the spendthrift trust, creditors are still limited under California Probate Code Section 15306.5(c).  This section indicates that amounts which are “necessary for the support of the beneficiary and all the persons the beneficiary is required to support” are exempted.  This means that if you can prove that all the benefits of the inheritance are necessary for the support of you and your family, creditors will not be able to reach those benefits and the trustees of the trust will not be required to pay the creditors.  There are different ways of proving that the amounts are necessary for your support in your bankruptcy case.  You should consult with an experienced bankruptcy attorney to ensure your inheritance is protected as much as possible in your bankruptcy case.