Establishing an estate plan is a wise and responsible choice. You know your property will be distributed according to your wishes after you pass away and that the estate administration process will be made easier for your loved ones.
But what happens if unexpected circumstances cause you to declare bankruptcy and you pass away before the bankruptcy is complete? How does this impact your estate plan?
What happens to your estate plan, and more specifically, your debts, in this situation depends on various factors.
The type of bankruptcy you filed
A Chapter 7 bankruptcy discharges all your qualifying debts through the sale of certain assets. A Chapter 13 bankruptcy allows you to pay off your qualifying debts on a three to five-year payment plan.
Chapter 7 bankruptcy involves appointing a trustee who administers the debt discharge process. Assuming the trustee is already appointed when you pass away, the bankruptcy process can typically continue as usual.
This means your qualifying debts will still be discharged. Your beneficiaries or heirs should not be involved with the process or be responsible for paying any of the debts.
The situation is more complicated for your heirs if you were in a Chapter 13 bankruptcy and still involved in the three to five-year payment plan.
In this case, the bankruptcy court may choose to discharge the bankruptcy, leaving the remaining debts outstanding. Alternatively, your beneficiaries could choose to continue to make your payments under the Chapter 13 payment plan until the debts are discharged.
This choice is up to the beneficiaries. They are not required to continue to make your Chapter 13 bankruptcy payments after you pass away.
Real estate and personal property
If you owned a home and had a mortgage, your beneficiaries have an incentive to keep making your Chapter 13 payments. Many people choose Chapter 13 plans specifically to keep their homes.
Continuing to make the payments will keep the home out of foreclosure. The same reasoning applies for other types of secured debt, such as vehicles, furniture or other personal property. Your beneficiaries can choose to make payments to keep these assets.
Another reason beneficiaries may choose to continue to make Chapter 13 payments is to discharge the debt and receive a portion of their estate inheritance, since Chapter 13 payments usually involve paying less on debts than fair market value.
There are other factors your beneficiaries may consider when determining whether to keep making the Chapter 13 payments, such as the amount of the debt, how much time is left on the payment plan and their chances of keeping the secured property if they continue to make payments.
Bankruptcy with your spouse
What happens if you enter the Chapter 13 payment plan with a spouse? Your spouse has several options if you pass away.
They can ask the court to lower the monthly payments to only account for the debt that belonged to them. If the debt was all joint debt, they can still request a lower monthly payment or a hardship discharge if there is a loss of income.
As with your beneficiaries, a spouse who can continue making the Chapter 13 payments can generally keep the portion of assets they would receive under your estate plan.