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Is a Trust Fund Exempt in a Bankruptcy Filing?

Even the well-to-do fall on hard times. This happens with spectacularly-compensated athletes, Hollywood celebrities and the progeny of bluebloods – many of whom file for bankruptcy. It’s a little less surprising when overspending or injudicious investments happen to second and third generations of those who earned the money, the so-called “trust fund kids.”

The fallen fortunes of many make the headlines, but what is perhaps most interesting is what happens in bankruptcy court. In the case of heirs, the benefactor can establish a provision in the trust fund that prevents the inheritor from using a trust fund before he or she has full control of it.

The provision is known as a spendthrift clause. Although heirs are typically aware of the funds they will receive upon the death of a benefactor, the spendthrift clause prevents heirs from using the trust fund as collateral or any other assignment of its value to a third party. The clause nullifies any written assignments that the heir makes regarding the trust fund.

Bankruptcy laws vary by state, but spendthrift clauses can also protect such assets in the case of a bankruptcy. Without this clause, however, the corpus of the trust is subject to asset dissolution in a Chapter 7 filing and perhaps also a Chapter 13 bankruptcy.

It often makes sense to work with a bankruptcy attorney to sort through the implications of a bankruptcy when a trust fund is involved. In some cases, the heir may be advised to work out financial difficulties without filing for bankruptcy.

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