Can bankruptcy tap surprise inheritance?

To Her Credit columnist Sally Herigstad
Sally Herigstad is a certified public accountant and the author of "Help! I Can't Pay My Bills: Surviving a Financial Crisis" (St. Martin's Press, 2006). She writes "To Her Credit," a weekly reader Q&A column about issues involving women, credit and debt, for, and also wrote for MSN Money, and, and has guested on Martha Stewart Radio and other programs.

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Question for the expert

Dear To Her Credit,
I filed for Chapter 13 bankruptcy in November 2011. My aunt had passed away in 2005, and I just now found some unclaimed funds from MetLife and Praxair mutual funds. I was the executrix of the estate. The mutual funds state that I am the beneficiary. The MetLife funds were an insurance policy she outlived. She was 101. There are five heirs left. Do I have to split MetLife with them and report the mutual funds to my trustee? Do I have to turn these funds over to him seeing as it was before I filed? -- Bobbi

Answer for the expert

Dear Bobbi,
Yes, you must report the money to the bankruptcy trustee. Colorado attorney Kevin D. Heupel says, "If she is still active in her Chapter 13, then she will need to disclose the inheritance as it is property of the bankruptcy estate."

Your case has an unusual twist in that your aunt died seven years ago. If the funds had been found back then and disbursed, they would have no effect on your bankruptcy filed in 2011 (unless, of course, the money helped keep you out of debt!). Bankruptcy law provides that you must report money when you "become entitled to" it within 180 days of filing. Generally, you become entitled to an inheritance when someone dies, so that is the important date. However, in the case of newly discovered funds, your creditors could argue that you became entitled to the funds when you discovered them. That would put them well within the 180 day period after you filed.

The fact that you filed for Chapter 13 is also a game changer. In a Chapter 7 bankruptcy, most debts are wiped away or paid with pennies on the dollar, and the debtor walks away with a fresh start. A person who files for Chapter 7 bankruptcy could win the lottery 181 days later, and his ex-creditors are out of luck.

Chapter 13 bankruptcy, which you filed for, is not so simple. The courts make a plan for you to pay off your debts within three to five years. You live on a very strict financial budget until those years are up. In return, you get relief from collection tactics and generally some reduction in the amount you owe. During those years you are on the court-ordered plan, your "disposable income" is supposed to be used to pay your debts. If you receive any kind of windfall, the courts could say you should pay more toward your debts.

Just because you have to report the money, however, doesn't mean you will have to pay it all to your creditors. "That depends on state law and whether there are any exemptions available to protect the funds," says Heupel. "It's possible that she might have to turn over all of the funds, none or a portion. Without knowing what state she lives in, I cannot tell what that outcome will be."

You will have to distribute the MetLife funds according to your aunt's will. It is very important that you do so exactly as required, even if it is a small amount and it doesn't seem worth the trouble. If the other heirs find out they've been shorted, they can bring a petition to the court. You could not only have to pay back the funds (which by then may have been disbursed to your creditors), but you could also be charged with a criminal felony.

Another thought: If you received a substantial amount of money -- enough to pay off your debts -- consider dropping the bankruptcy case altogether. Only one out of three Chapter 13 filers complete their repayment plan. The rest drop out. In a Chapter 13 bankruptcy, the courts are in charge of your finances for years to come. If you have enough money now to take back control of your finances, I would encourage you to do so.

Laws are seldom simple, because life almost never is. Cases of people receiving money at various stages of filing for bankruptcy have gone to court, with varying results. If you have a lot of money at stake, please get the advice of a good attorney in your state.

See related: Inheritance rules after you've filed for bankruptcy, Can collectors come after your inheritance?

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Updated: 10-16-2018