How Bankruptcy Affects Inheritances and Estate Plans

Last updated September 16, 2022

It’s the question you’ve been dreading...
Should I file for bankruptcy?
It’s not ideal, but filing for bankruptcy is often your last chance to get your feet back on the ground when you’re drowning in debt.
Still, it’s important to understand how this legal financial status affects your estate plans.
Here, we’ll discuss common forms of bankruptcy filings for individuals and how they impact inheritances and estates.

What happens when you declare bankruptcy?

When declaring bankruptcy, you’re telling authorities you cannot repay creditors because your debts and liabilities exceed your assets and income (i.e., you’re insolvent). In this case, you petition the court to erase your debt.
But, of course, there’s a catch.
You’ll need to meet the requirements for a bankruptcy filing to qualify for a court-ordered bankruptcy discharge. Typically, this means you’ll need to meet with an economic advisor and liquidate your assets or create a repayment plan to clear a portion of the debt before the courts erase the rest.
Once you’re discharged, you’ll find relief from your obligation to repay your debts. Creditors cannot continue collection actions (e.g., calls, letters, and civil suits) on discharged debts.

Who has jurisdiction over bankruptcy?

Federal laws govern bankruptcy, and each district has a federal judicial bankruptcy court to hear these types of cases. (However, state laws also apply to issues involving property rights, so many systems can be at play.)
The bankruptcy code acts as a framework for providing economic relief and settling a claimant’s debts. While there are nine chapters of the code, individuals typically file under Chapters 7, 11, or 13:
  • Chapter 7 relieves the debtor through liquidation (the sale) of their assets to pay back creditors.
  • Chapter 11 relieves the debtor through the reorganization of debts—a plan created by a committee of creditors to which the debtor owes money. (This chapter is more often used by small businesses.)
  • Chapter 13 relieves the debtor through adjusted debts (usually allowing you to keep some property) and a payment plan that spans three to five years.

What is a bankruptcy estate?

When someone files for bankruptcy, most of their money and assets become part of a bankruptcy estate. (However, certain exceptions may allow you to keep some property.)
Typically, this estate is under the control and protection of the bankruptcy court and an appointed bankruptcy trustee. The trustee acts as an administrator for the estate, while the estate itself is considered the temporary legal owner of the debtor’s assets and property.
The bankruptcy estate’s ownership over the debtor’s property may extend to any other assets the debtor receives while bankrupt—including inheritances.

How does bankruptcy affect inheritances?

Bankruptcy affects inheritances differently depending on which chapter you file under. Also, the timing of the inheritance may affect whether or not it’s included in your bankruptcy estate.

Chapter 7

If a person files under Chapter 7, any inheritance is usually lumped into the liquidation process.
For example, if a debtor receives a $30,000 inheritance, it goes toward their total debt as a lump-sum payment. Likewise, if the debtor inherits a valuable car, it’d be liquidated for cash and then paid to creditors.
However, any inheritances received 180 days after filing under Chapter 7 will remain the property of the debtor and not the property of the bankruptcy estate.
Notably, this time limit usually depends on when the person passes away—not when beneficiaries get their inheritance.
In other words, if the person leaving the inheritance dies within 180 days of the debtor filing for bankruptcy, the bankruptcy estate replaces the debtor as the beneficiary in the Last Will. So, if their Will is stuck in probate court for over a year, the money usually goes to the bankruptcy estate because the person died within the 180-day limit.

Chapters 11 and 13

If a person files under Chapter 11 or 13, the time elapsed after filing might not matter, as a judge can choose to take your inheritance into account to amend your repayment plan. This is because the bankruptcy code also has a provision for any property the debtor acquires “before the case is closed, dismissed, or converted.”
For instance, a large inheritance could be a significant increase in income, thus increasing your ability to make higher payments. While judges have allowed debtors to retain their inheritances in some cases, they most often decide to settle debts instead.

How can a bankruptcy trustee find out about inheritances?

Inheritances are a matter of public record. As such, a bankruptcy trustee can learn of inheritance by looking up the information or when contacted by:
  • The executor of the Last Will
  • A relative of the deceased
  • The probate court
However, it’s best practice to inform your trustee whenever your financial situation changes. This includes inheritances. Withholding any information could bring bankruptcy fraud charges against you.

Can I protect my inheritance?

In most cases, there’s little you can do to protect your inheritance from becoming a part of your bankruptcy estate. It’s best to speak with a lawyer or your economic advisor to review your options.
For example, a relative could buy the property you inherit so that it stays in the family. In this case, the money you get from their purchase can go towards repaying your debts.
Beyond that, a lawyer may be able to find exemptions in the bankruptcy code that apply to you. They can also explain ways you may be able to spend the money (e.g., to meet basic needs, not to make extravagant purchases) or how to use trust accounts (if possible) to protect the inheritance.

How does bankruptcy affect my estate plan?

While under the ownership of a bankruptcy estate, you lose some control over your money and property. This is because the bankruptcy trustee must ensure you’re meeting your financial obligations.
In the short term, you likely won’t be able to make any big investments or purchases, and you might lose some property too. In the long term, bankruptcy leaves a mark on your credit score for about seven to ten years.
So, what does this mean for your estate plans? Well, you might have a hard time rebuilding your credit and getting a loan for a mortgage.
And remember: if you want to leave anything to your loved ones, it’s a good idea to deal with bankruptcy before it’s too late.
Bankruptcy impacts the instructions in your Last Will for distributing your property and assets after your death. If you have outstanding debts, authorities will pay them first before dealing with the gifts you intended for others. This is the case whether you’re bankrupt or not.
If you’re bankrupt and need to sell certain assets that you wished to leave as gifts in your Last Will, you should update your Will and remove those gifts.

Bankruptcy and a Power of Attorney

A Power of Attorney must grant your agent specific powers to represent you during bankruptcy proceedings. Even so, your agent’s ability to deal with your assets and debts will be limited in the same way as if it were you acting.
If you become incapcitated part way through bankruptcy proceedings, your agent would be able to act as your representative for the remainder of the proceedings (as long as they have the power to do so under the POA).
However, if your attorney-in-fact is the one who files bankruptcy, the court may investigate their authority and your capacity to ensure there isn’t any fraudulent or illegal behavior occurring. Otherwise, the agent can act on your behalf and the trustee will still manage the bankruptcy estate.

How long after bankruptcy can I buy a home?

The time it takes to get a home loan after bankruptcy depends on how quickly you can increase your credit rating.
With a Chapter 7 filing, you may be able to liquidate your assets and settle your debts within a few months. With Chapters 11 or 13, however, it may take years to be discharged from your debts.
To top it off, mortgage brokers often won’t approve loans until at least two or more years after you’re discharged. However, with the court’s approval, some types of mortgages are available after being 12 months into a Chapter 13 repayment plan.
Truth be told, your credit score suffers terribly after you file for bankruptcy. Plus, companies can see bankruptcy history on your credit report for seven to ten years after the fact.
Is it even possible to raise your score after this? You bet it is!
There is no one-size fits all plan for recovering after going bankrupt. However, taking these steps can improve your eligibility for home loans:
  1. Pay your bills on time and start a savings fund that you contribute to regularly.
  2. Get a secured credit card to start a history of responsible credit use.
  3. Ask a co-signer to help you qualify for a home loan.
Generally, you’re better off saving money for a down payment (or to secure another loan) than relying on a line of credit. And, frankly, rebuilding your credit score and saving money for a home may take several years of patience and discipline.

Can an estate file for bankruptcy?

If you die before paying off your debts, the executor of your estate will not be able to claim bankruptcy to protect any inheritances you may wish to leave behind. According to the bankruptcy code, only individuals and legal business entities can file for bankruptcy.
However, if you die while in the midst of filing for Chapter 7 bankruptcy, your executor can continue the case on your behalf. They’ll help oversee the liquidation of your assets and repayment of your debts. After this, the remainder of your estate (i.e., your residuary estate) can go to the beneficiaries named in your Last Will and Testament.
If you die before closing a Chapter 11 or 13 bankruptcy case, things can get a little complicated. Depending on the circumstances, the court may choose to continue the case as if you hadn’t died. Your executor may work with the bankruptcy trustee to follow through with the repayment plan.
The reality is, if you have an insolvent estate, your beneficiaries probably won’t have anything left to inherit.
Still, your loved ones can take action if you die during bankruptcy by:
  • Asking for the case to be dismissed
  • Asking for a hardship discharge
  • Asking to convert the case to a Chapter 7 filing (then liquidating the estate to satisfy the bankruptcy terms)

Managing your estate while bankrupt

Bankruptcy can easily take hold of family inheritances if you don’t plan accordingly.
If you suspect you may gain an inheritance while bankrupt, be proactive and contact a lawyer to see if you can protect it. Trust accounts and different beneficiaries can help keep family heirlooms, property, and other assets away from creditors.
If you want to leave a legacy behind for your loved ones, be responsible for your earnings and stick to your repayment plan. Once you’re discharged, expect years of hard work and discipline to get yourself back on track.
Because, in a bankruptcy case, can you really afford not to?
Get affordable legal advice online
Update your
Last Will and Testament
after any big life changes
Know someone who could benefit from this information? Pass it along