A Living Trust in Bankruptcy
Filing for bankruptcy has serious and far-reaching financial implications. Assets held in a living trust are generally not protected from the reach of your creditors or the bankruptcy court, while assets held in an irrevocable trust typically are. Before you file for bankruptcy, or create a trust to protect your assets, consider all of your options, the implications of each and explore financial alternatives.
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Living Trusts
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A trust is a legal instrument that is created when a person, known as the settlor, transfers property to a trustee, who then holds that property for the benefit of a third party, who is known as the beneficiary. A living trust is a revocable trust, meaning the trust can be modified by the settlor, and in some instances, the trustee, after it has been created. Living trusts are used in situations where the duration of the trust is unknown or the administration of the trust may need to be modified at a later date.
Bankruptcy
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Bankruptcy is a legal process that absolves a debtor of his debts, with some limitations. Individuals usually file under Chapter 7, which is a total liquidation of assets to satisfy debt, or Chapter 13, which is a reorganization of debt through a repayment plan. In most instances, debtors can keep their assets in a Chapter 13, but assets are lost in a Chapter 7.
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Misconceptions
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Many debtors think putting assets into a living trust will protect the assets from creditors or the bankruptcy court. This is not true. Creditors and the bankruptcy court can reach assets held in a living trust since a living trust can still be modified by the debtor, who is the settlor. Since the debtor still technically has control of the assets, they are still considered in his possession and subject to seizure.
Irrevocable Trusts
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An irrevocable trust, unlike a living trust, cannot be modified and is effectively not revocable. Once an irrevocable trust is made, the terms cannot be amended or revised. Since the debtor (the settlor) relinquishes control of the assets completely this way, assets in an irrevocable trust are typically shielded from the reach of creditors and the bankruptcy court. In exchange, however, the debtor also gives up the asset.
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