Can Trusts Protect Assets When You File For Bankruptcy?
People are always trying to come up with creative ways to protect assets from being taken in bankruptcy. In most cases, a debtor won’t lose any assets—most will fall under an exemption. But in some cases, there are non-exempt assets, and debtors often try to do creative things to keep the property from being taken.
Sometimes, being creative is a good thing. The laws are flexible, and with proper planning and full disclosure, there are innovative ways to protect property both from creditors and from the bankruptcy court. Of course, there are also creative things that people do that either don’t work or are downright illegal.
Trusts and Bankruptcy
One such thing some consumers try is the creation of a trust. Many consumers believe that all they have to do is create a trust, move their property and assets into the trust, and voila! The property is no longer in the debtor’s name, and thus, the property cannot be taken by the court. After all, the trust “owns” the property, not the debtor.
Except it doesn’t exactly work that way, because the debtor is still the owner of the trust, and thus the trust (and everything the trust “owns”) is part of what the debtor owns. But that’s not to say that trusts can’t be a part of a smart bankruptcy strategy, as well as a smart asset protection strategy.
As a general rule or a rule of thumb, there are two kinds of trusts. One is a revocable trust. These are trusts that will distribute assets to family (or whoever you designate) after you pass away. Your family will not have to go to court or have your estate probated.
The problem with a revocable trust when it comes to bankruptcy, is that there is no bankruptcy protection. You are still the owner of the trust. You can pull assets from it, modify it, or destroy it at any time, whenever you should choose. You still completely control the trust. Because of that there are very few asset protection benefits, and even fewer bankruptcy protections.
There is a bit more protection with irrevocable trusts. With an irrevocable trust, you do not administer the trust, or make decisions about the assets put into the trust—someone you designate does that. You have no control over the trust, so generally the bankruptcy court cannot touch it. There are also other estate planning benefits with irrevocable trusts, such as the ability to keep getting certain government benefits, by putting assets in an irrevocable trust.
However, even an irrevocable trust may be subject to the bankruptcy court, depending on when it was created. The trust has to be created before you knew you were filing for bankruptcy, or before you had any legal claims pending against you.