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Are Revocable Trusts Protected in Bankruptcy?

Many people have opted to have a living trust created that provides for the distribution of their assets after their death. Most of the living trust that are created are revocable, meaning that they are subject to change. A revocable trust can the modified, altered, to change the assets that are in the trust and who the assets are distributed to. A revocable  trust names beneficiaries who will be entitled to a certain portion of the assets after the settlor's death (the creator of the trust). If  you are listed as a beneficiary of a living trust you may be worried whether filing for bankruptcy may put the assets in the trust at risk.

When you file for bankruptcy , your assets become part of a bankruptcy estate that can be used to pay creditors with. Each state has bankruptcy exemptions  that protects certain assets from being liquidated to pay creditors with. If you are a beneficiary of a living trust then you need to understand whether it will become part of the bankruptcy estate and whether it can be used to pay creditors with. If  trust is a revocable living trust at the time the bankruptcy case was filed then generally courts have ruled that the trust is not part of the bankruptcy estate where it contains a valid spendthrift provision. Section 541 (c)(2)of the bankruptcy code provides that " a restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title".   What this means is that if you are a beneficiary of a revocable living trust with a valid spendthrift provision, then the trust is not part of the bankruptcy estate. A spendthrift trust  is a trust that prohibits the assets from being assigned, transferred or encumbered for the benefit of creditors before the asset is distributed to the beneficiary. If the revocable trust contains a provision  that is considered valid under your state then the trust assets do not become part of the bankruptcy estate.

If you are a considering filing for bankruptcy and are a beneficiary of a living trust it is important that you consult with an experienced bankruptcy attorney prior to filing. It is important that you aware of any potential risk that may allow the bankruptcy trustee to liquidate the trust assets for the benefit of creditors.


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