Most people have the desire to leave some type of legacy to their family members after they die. There may be some assets they would like to leave to a loved one like a house, a car, or other monetary gifts. However, what happens if you die with significant debt beyond your means to honor a repayment plan or other financial obligations? Can an estate file for bankruptcy to protect what is left of personal property from creditor claims? Let us review all these questions as a part of estate planning.
What is estate planning?
Estate planning is about how you want your assets distributed after you die. This includes personal property, real estate, insurance, and any retirement account. It can be in the form of either a Trust or a Will. They both will get the job done. However, setting up a trust costs more but allows you to set conditions for distribution and avoids probate court. Most people can get by with a simple will since your beneficiary are exempt from paying taxes on assets less than $12 million. This leaves a lot of wiggle room for many of us. For those of you with assets above $12 million, the inheritance tax starts at 40%.
Please note that community property states that the right of survivorship is a legal distinction that allows two spouses to equally share assets through marriage as well as pass on assets to the other spouse upon death without going through probate per Rocket Mortgage.
The difference between a trust and a will.
A basic Will should assign guardianship to your children and/or pets. Appoint someone to handle your affairs after you are gone. It allows you to leave gifts to people who are dear and near to you. You can also exclude people from getting any of your personal property. It allows you to specify your final arrangements and any special requests. You can list all your healthcare wishes, assign a healthcare agent, and grant access to medical records.
On the other hand, the trust allows for all the above plus two additional benefits if you have a substantial amount of cash, personal property, and real property. It may be in the best interests of your children not to release all your assets all at once. Especially, if they are at a very young age and the amount is in the millions. Hence, a better option might be to stagger the distribution over time, such as at 21 years old, at 30 years old, and then again at 49 years old. Thereby, not overwhelming them with the responsibility of newfound wealth. The other benefit is avoiding probate court to distribute your assets. A living trust will allow your personal property to be transferred directly to the intended persons without the probate process’s cost. It can all be handled by your successor trustee with simple paperwork.
Disadvantages of Trust
- Trust can be more expensive than a will to set up and administrate
- Trust can be complicated to set up and terminate
- You must hand over the control of your assets to the trustee
What happens to your stuff and your debt when you die?
65% of millennials are unsure they’ll die debt free, while 83% of retirees over 72 aren’t sure per debt.org. There is always the chance that no matter how much time we spend budgeting and saving some unforeseen event could happen that can cause our finances to spiral out of control. This can lead to the possibility of bankruptcy.
It also does not help that close to two-thirds of the U.S. population, 64% or about 166 million adults are living paycheck to paycheck per LendingClub. However, if this debt exists after you die who must pay this off? What happens when someone dies in debt? Who is responsible for paying the outstanding debts? Your estate will be responsible for paying off the outstanding debts. However, can an estate file for bankruptcy?
Estates and Bankruptcy
If you have a will or a trust the debt will have to settle before any assets can be transferred to your beneficiary. However, if there are not sufficient assets to pay off the debt, the estate cannot file for bankruptcy. The bankruptcy code states that only individual debtors can file for bankruptcy. Therefore, all and any remaining debt will have to be paid out of the assets of the deceased prior to distributing to their beneficiaries by the bankruptcy trustee. This will include unsecured debts such as credit card debt, personal loans, student loans, medical bills, and utility bills. Money owed to unsecured creditors will remain unpaid once there is no money or property left to liquidate.
However, if you are currently in the process of filing for bankruptcy and die the bankruptcy attorney will continue with the bankruptcy case. If you file Chapter 7, all non-exempt assets considered property of the estate will be liquidated to pay off all debt. Therefore, any nonexempt property, such as vacation homes and new or expensive motor vehicles will be sold.
If you file for Chapter 13 bankruptcy, which is a type of repayment plan lasting a few years. The trustee and the surviving beneficiary may have to petition the court for how to proceed with the repayment process. Hence, the type of bankruptcy filed is important.
One way to avoid losing your assets to bankruptcy is to set up an irrevocable trust. It is a trust that cannot be changed or ended after its creation. It is mainly set up to limit estate taxes or to shield assets from creditors. The caveat is that it must be set up years before a bankruptcy proceeding is started.
Bankruptcy proceedings are governed by federal law. Therefore, please seek legal advice prior to making any decisions regarding bankruptcy protection. Since bankruptcy law is part of the federal system and not state law; hence, it does not differ much from state to state. However, states do decide on their own property exemption laws, which will determine what you are able to keep or must give up in a Chapter 7 bankruptcy process.
This is content is for informational purposes only and is not intended to be legal advice. You should consult a lawyer regarding all legal matters.
Deciding to create a plan for your real estate property, household goods, bank accounts, investment accounts, insurance policies, and repayment of debts is the best thing you can do for your loved ones and friends. Here is a course of action to get your estate in order:
- Maintain a Budget
- Pay down or eliminate all debt
- Live within or below your means
- Have life insurance
- Invest in retirement savings accounts
- Have a will or trust
- Keep all this information in a safe location
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