Using Your Estate Plan to Protect Your Family Against the Threat of Creditor Claims
Your estate plan can only provide real peace of mind when structured to eliminate the greatest threats to your legacy. For many families in Texas and Arkansas, long-term risk often involves financial liabilities. If you owe anybody money—a bank, a credit card company, or somebody who won a money judgment against your business—they could file a claim against your estate, seizing your assets and, potentially, depriving your heirs of the inheritance you wanted them to have.
You don’t have to take chances with your estate. Read more to learn how to protect your estate from creditor claims, or send Ross & Shoalmire a message online to speak to an estate planning lawyer and schedule your initial consultation.
Anticipating Creditor Claims Against Your Estate
Your estate plan can’t account for every obstacle, but anticipating threats to your estate goes a long way in guaranteeing your heirs’ right to an inheritance.
Here’s what you need to know about creditor claims, how they work in probate, and what they look like during trust administration:
Assessing the Risk to Your Estate
Debt doesn’t always disappear upon death.
Although most forms of debt can’t be transferred to your heirs, many creditors are still entitled to file a claim against your estate. You could be at risk if:
- You have outstanding loans
- You have any type of credit card debt
- You owe money on a home, motor vehicle, or other asset
- You own a company and have not yet separated your business assets from your personal assets
- You are the subject of a judgment or other court-ordered sanctions
Even if you don’t think it’s likely that you’ll die with enough debt to jeopardize your heirs’ inheritances, you should always account for the possibility of unexpected liabilities. However, the details of your asset protection plan will most likely be contingent on whether you intend for your estate to be dissolved through probate or managed by a trust.
Probate and Creditor Claims
Probate is the court-administered process of dissolving a deceased person’s estate.
Although Texas and Arkansas have their own probate codes, the basic process is the same in both states. In general, probate will almost always consist of the following steps:
- Your executor initiates probate by filing a petition and presenting your last will and testament to the court.
- After your will has been proven, your executor must notify all interested parties that they have initiated probate. Interested parties to your estate include immediate family members, named heirs, and potential creditors.
- Your executor is broadly responsible for inventorying and managing your estate assets until probate has concluded.
- If any creditors file a claim against the estate, your executor must assess the claim, determine whether it was placed in good faith, and pay all valid debts.
- Once your creditors have been paid, your heirs are entitled to the remainder of your estate.
In both Texas and Arkansas, notifying creditors of probate is mandatory.
If an executor fails to provide proper notice to the estate’s creditors, a judge could order repayment of estate debts after the standard window for collection has passed. In some cases, executors themselves could be held liable for any resulting losses, whether on the part of a creditor or an heir.
Aside from creditor claims, most estates in probate are also vulnerable to federal estate taxes levied on certain high-value estates.
Trusts and Creditor Claims
If you establish a trust before passing away, your trust assets will be separated from your other estate assets. In general, trust assets are considered non-probate assets and, by extension, off-limits to most creditor claims. However, this does not mean that trusts provide any sort of blanket immunity to debt-related liabilities.
Your trust could still be subject to creditor claims if:
- Your trust is a revocable living trust and you are still alive
- Your trust was improperly formed under Texas or Arkansas law
- Your trust was created solely for the purpose of shielding assets from creditors
So, though trusts can provide enhanced protection against creditor claims, they must be structured to accommodate individual needs and unique circumstances.
Protecting Your Estate with an Asset Protection Plan
Your creditors have a legal right to file a claim against your estate.
Although not all creditor claims are valid, your executor has a binding duty to review your accounts and repay whichever past-due debts remain enforceable and within the statute of limitations. If your executor fails to do so, they could be held personally liable for your creditor’s losses.
You don’t have to leave your executor—and your family—in a vulnerable position.
Here’s what you could do to begin protecting your estate from creditor claims before it ever goes to probate:
Strategic Gifting
Your estate plan doesn’t have to revolve around your death.
If you’re afraid that your estate might run afoul of an unexpected creditor claim or the federal estate tax, you can begin minimizing your liabilities while alive by giving gifts to friends, family members, and preferred charities. Some transfers, like transfers to your spouse, do not count against your annual or lifetime federal gift tax exemption.
In either case, you should always take a cautious approach to gifting. Even though giving a gift to a spouse, family member, or other heir removes the asset from your estate, creditors can still challenge the validity of your transfers. If a court finds that a series of exchanges were made for the sole or specific purpose of avoiding a creditor’s claim, it could void the transfer, creating an even greater liability for yourself and the gift’s recipient.
Limited Liability Companies
A limited liability company, or LLC, is an easy way to separate your personal assets and liabilities from your estate assets and liabilities.
The protection offered by an LLC works in both directions: you’re shielded from creditor claims filed against your company and its assets, while your company remains protected from creditor claims filed against you and your personal assets.
Leverage Homestead Exemptions
Texas and Arkansas both have “homestead” laws that protect an individual’s primary place of residence from creditor claims, court judgments, and other legal actions. These same rights can “descend” to a deceased owner’s surviving spouse or minor children, allowing them to inherit the property without risk and outside the purview of probate.
However, homestead protections are imperfect because they only guarantee property-based inheritances for a small subset of potential heirs and beneficiaries.
Asset Protection Trusts
An asset protection trust is a type of irrevocable trust that can be established if liabilities seem likely to arise later in your own life or during probate.
Since these trusts are irrevocable, their terms cannot be changed and their assets must be managed by a trustee. This arrangement deprives you of a limited degree of control over your assets, but ensures that they are fully separated from your other estate and probate assets.
Asset protection trusts can be established under the laws of most states and many foreign countries. Some offshore havens offer an exceptional degree of protection for high-value assets, with countries like the Cook Islands regularly refusing to entertain creditor claims unless they are protected by international law or predicated on incontestable proof.
Insurance Policies
Many insurance policies, including life insurance policies, are generally exempted from creditor claims. This is because most policies have “beneficiary designations,” or contractual arrangements that permit the transfer of funds to a designated beneficiary outside of probate.
