How Does Being the Beneficiary of a Trust Affect Bankruptcy in Minnesota?
If you are considering bankruptcy in Minnesota and you are the beneficiary of a trust, you may need to consider whether the trust could be taken from you as non-exempt asset. The answer depends on several factors, including the type of trust, the language in the trust document, whether you have received a distribution, and whether the trust includes a valid spendthrift provision.
Under federal bankruptcy law, filing bankruptcy generally creates a bankruptcy estate that includes the debtor’s legal and equitable interests in property. However, federal law provides an important exception for certain trust interests. Under 11 U.S.C. § 541(c)(2), an interest in a trust that is subject to a legally enforceable restriction on transfer may be excluded from the bankruptcy estate.
Spendthrift Trusts and Bankruptcy
Minnesota law recognizes spendthrift provisions that restrict both voluntary and involuntary transfers of a beneficiary’s interest. A valid spendthrift provision can prevent creditors from reaching a beneficiary’s interest in the trust or a distribution before it is received by the beneficiary.
This protection can be particularly important in bankruptcy. Minnesota bankruptcy courts have held that a beneficiary’s interest in a properly drafted spendthrift trust may be excluded from the bankruptcy estate. In one Minnesota case, a debtor was the beneficiary of his deceased mother’s trust. Because the trust contained a valid spendthrift provision, the court determined that the debtor’s interest was excluded from his bankruptcy estate.
However, not every trust provides the same protection. If the beneficiary created or funded the trust for his or her own benefit, different rules can apply. Minnesota law places limits on self-settled trusts, and courts have held that a person generally cannot create a trust for themselves and use a spendthrift provision to shield the assets from creditors.
What About Trust Distributions?
Timing can also matter. A beneficiary may have significant protection while assets remain inside a properly structured spendthrift trust, but once money or property is distributed to the beneficiary, it may become part of the beneficiary’s property and potentially subject to bankruptcy administration.
Minnesota law also provides that a creditor generally cannot compel a discretionary distribution from a trust merely because the beneficiary owes money. However, mandatory distributions that have become due and remain unpaid can be treated differently.
Trusts and Bankruptcy Require Careful Review
Being named as a beneficiary of a trust does not automatically mean that the trust assets will be lost in bankruptcy. Likewise, being a beneficiary does not automatically protect those assets. The specific terms of the trust, your rights as a beneficiary, the identity of the person who created and funded the trust, and the timing of any distributions can all affect the outcome.
If you are a beneficiary of a trust and are considering filing bankruptcy in Minnesota, it is important to disclose the trust to your bankruptcy attorney and provide a complete copy of the trust documents. An attorney can review the trust and determine whether your beneficial interest is likely to be considered part of the bankruptcy estate.
Because trust and bankruptcy laws can interact in complicated ways, getting legal advice before filing can help you understand your rights and avoid unexpected consequences. Contact Hoglund Law for a free consultation at (651) 842-3735 today.