Inherited assets which arise during bankruptcy can present issues because they are not exempt under New Jersey bankruptcy law and are subject to liquidation as part of the bankruptcy estate that is created when a bankruptcy is filed. However, there are estate-planning devices that can help to protect potential assets that may be inherited during a bankruptcy. These are called spendthrift trusts.
A well drafted spendthrift trust, along with certain built in discretionary powers to the Trustee of the Trust can fully protect assets which may be inherited during bankruptcy. This type of asset shelter can be a good idea if a loved one is in poor health, financially turbulent or facing a divorce proceedings. Also, it is a good way to leave an inheritance to family members facing bankruptcy and will provide the greatest benefit to their successors, while also protecting the money from their family member’s creditors. The law is proscribed in , which provides that an “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.” This language preserves restrictions placed on the transfer of the debtor’s interest in a trust commonly referred to as “spendthrift trusts.” Section 541(c)(2) is written in such a way that a spendthrift trust does not become part of the bankruptcy estate when a beneficiary of such a trust files for bankruptcy. When an asset is not part of the bankruptcy estate (in this case a “spendthrift trust”), it is not subject to liquidation by the bankruptcy trustee, and is therefore sheltered from potential creditors.
The issue then becomes what qualifies as a “Spendthrift Trust” under New Jersey Law. A Spendthrift Trust is a trust that is structured so that it is non-transferrable by the beneficiary. This means that the beneficiary has no control over the contents (assets) of the trust, and will only receive whatever benefits the trust provides. As previously stated certain “discretionary” language may be drafted into a trust and anything that gives the trustee less than complete discretion to distribute or not, income and/or principal to any beneficiary of the trust, will effectively reduce the ability of a trustee to shield the trust assets from a beneficiary’s creditors
Therefore, a spendthrift trust that qualifies under New Jersey law with complete trustee discretion is safe in bankruptcy. A spendthrift trust (without complete discretion given to the trustee) will still be safe in bankruptcy however; the protection would only apply to the corpus of the trust and not to distributions that may be made in the 180 following the filing of a bankruptcy case. Those distributions would be part of the estate, would not be exempt and would therefore be subject to liquidation by the bankruptcy trustee.
Because of the intricacies of Bankruptcy law and their interplay with Trust and Estate law, any pre-bankruptcy estate planning of this sort is best done with the advice of a qualified Bankruptcy Attorney, as well as, a Trusts and Estates attorney.If you are thinking of filing Bankruptcy our FAQ’s section answers many of the questions filers might have.
The New Jersey personal bankruptcy attorneys at Riviere Cresci & Singer LLC can answer any questions you may have concerning retirement funds in relation to your debt, or any general bankruptcy questions. If you live in New Jersey, including Little Egg Harbor, Allentown, Ocean Township, and Monroe, call us for a free consultation to find out how we can help you.