Trust Distributions May Not Always Escape Bankruptcy

Trusts may be effective at avoiding probate, but can they be subject to other legal or financial obligations? A recent article provides an example in the context of bankruptcy.

Specifically, a beneficiary of a living trust attempted to recover assets from the trust after the creator passed away. In addition to a cabin, the trust contained about $1.8 million in assets. The trust document stated that assets would be distributed to the creator’s four children in equal shares. However, one of the children filed for bankruptcy, and creditors attempted to get at that child’s share of the trust assets.

As an attorney who focuses on estate planning knows, the issue of whether creditors can obtain trust assets often hinges on an examination of control: whether the debtor had access and control over the trust property. In the case of a living trust, the creator has access and control over the trust property during his or her lifetime. Indeed, a living trust is really a form of a revocable trust. Upon death, however, the trust becomes irrevocable, and the successor trustee must govern or distribute trust assets according to the trust document.

In this case, the trust document stated that the living trust would terminate upon the settlement of the trust creator’s estate. According to the bankruptcy court’s interpretation, settlement meant the point in time when the trustee had paid out the trust’s assets and substantially administered the creator’s estate — thus putting the trust assets within the beneficiary’s control and access.

As this post illustrates, the interaction of estate planning instruments and other laws can quickly become complex. To ensure that a creator’s intentions are fully realized, it is best to consult with an experienced attorney.

Source: Forbes, “Trust Beneficiary Checkmated By Bankruptcy Code 548(e) In Castellano,” Jay Adkisson, Aug. 11, 2014

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