Do I Get to Keep My Inheritance if I File Bankruptcy?

Few areas of consumer bankruptcy law cause more confusion and frustration than the issue of an inheritance.  Part of this reason is likely due to the fact that a loved one has recently died and this was their money and is was intended for me!  There is a natural and strong feeling of a bond between a mother and father, for example, and a child who is receiving their inheritance.  This is their final worldly gift and sign of love to their children.  And now a bankruptcy trustee is going to take it from me!!!  That hurts.

Adding to these feelings may be the size of the inheritance.  Sure, a few bucks is no big deal, but a lot of inheritances are huge.  Tens if not hundreds of thousands of dollars may be involved.  This is a lot of money and not something to sneeze at.

What are the rules when a person gets an inheritance with respect to bankruptcy?

1. The first rule is that it does NOT matter when you actually get the money or inheritance.  What matters is when you become entitled to receive it.  For example, if your Mom dies on January 4, 2013 and she leaves you an inheritance, then you become entitled to receive the inheritance on January 4, 2013……not when you actually get the funds or property.  Just because you haven’t actually received anything does NOT protect you.
2. If you are entitled to receive an inheritance before filing bankruptcy, then that inheritance belongs to your creditors.  However, if your inheritance is larger than the total of your debts, then you get to keep the excess amount after the creditors are paid in full and the bankruptcy trustee is paid for his or her services.
3. For Chapter 7 bankruptcies, if you become entitled to receive an inheritance within 180 days AFTER your bankruptcy is filed, then you lose the inheritance.  Rule #2 then applies.  Basically,  bankruptcy law pretends like you became entitled to receive the inheritance before the bankruptcy was filed.  For the sake of clarity, an example is called for:  If you become entitled to receive an inheritance on the 181st day after filing a Chapter 7, then the entire inheritance is yours!
4. In a Chapter 13 bankruptcy, the above three (3) rules apply as well.  But, there is another rule too.  If you receive an inheritance at any time that you are in a Chapter 13 bankruptcy (up to 60 months), then you may have to increase what percentage you pay back to your creditors….up to 100%.   Rule #2 always applies.  Technically, if a person in bankruptcy becomes entitled to receive an inheritance at any time before a Chapter 13 is closed, dismissed or converted, then that inheritance becomes property of the bankruptcy estate.   Thus, being in a Chapter 13 bankruptcy is not ideal if an inheritance is received at any time during the proceeding.  However, a Chapter 13 debtor generally has the right to dismiss their case at any time (this is not true for Chapter 7 debtors) and they normally also have the right to convert to a Chapter 7.  Thus, an individual that becomes entitled to receive an inheritance does have some control over the outcome of where the inheritance will go. Obviously, each case varies and requires individual attention and there are many possible outcomes.
5. ALL inheritances must be reported, regardless of whether or not your creditors are entitled to receive anything.  The best way to do this is to immediately contact your bankruptcy attorney with all of the specific details.  Failure to report or disclose the inheritance to the Bankruptcy Court and Trustee may result in criminal charges and a permanent denial of bankruptcy protection (even after the case is closed).

Proper planning may avoid problems.  Some funds are protected.

Not all is lost, thankfully.  In Nebraska and Iowa, you may still be able to protect a portion of your inheritance using the wildcard exemption.  Good legal advice and appropriate estate planning are critical factors also.  A parent or loved one planning on leaving an inheritance to someone having financial difficulties would be well advised to consider modifications to their estate planning, and specifically consider using a spendthrift trust.  Such changes could preserve the inheritance for the intended recipient and avoid a lot of distress in the future.