Bankruptcy and Life Insurance: Things You Need To Know
If you are filing bankruptcy, you may be concerned about your life insurance proceeds and whether they will enter the picture as part of your assets.
Depending upon the situation, most life insurance proceeds are immune from bankruptcy proceedings. However, there are some exceptions to this rule.
First, it is important to determine what type of bankruptcy you are filing. There are three types which are generally used by the average person: Chapter 7, which is a liquidation; Chapter 13, also called a “wage-earner” plan, in which you make payments to a trustee; and Chapter 11, which is a business bankruptcy.
Depending on what type of bankruptcy you file, some or all of your life insurance proceeds could be subject to the court’s jurisdiction.
If you are filing a Chapter 7 and you own a term-life policy, none of the proceeds will be subject to the bankruptcy. This is because a term life policy has no real value until the death of the beneficiary. However, if you are the beneficiary of someone else’s policy during the time of your bankruptcy, that money can be seized and distributed to creditors, as it is considered a personal asset.
If you are filing a Chapter 7 and you are the owner of a whole-life policy with a cash value, the treatment of that policy will depend upon the state in which you live. Most states do not allow bankruptcy courts to seize whole life policies as long as the beneficiaries are dependents or spouses, and as long as the insured does not cash in the policy.
In these states the policy will be excluded from the assets in the bankruptcy. However, some states do allow seizure of these assets. Your bankruptcy lawyer will be able to tell you which law applies in your state.
For Chapter 13 filers, the rules are much the same. Term life policies have no value and are not usually considered in the bankruptcy, while whole-life policies may or may not be considered assets, depending on your state’s law. If you die during the time of your Chapter 13 bankruptcy, proceeds from your life insurance may be required to pay your creditors under the terms of your plan.
Chapter 11 bankruptcies are far more complex than either Chapter 7 or Chapter 13, and therefore the treatment of life insurance assets are different. In a Chapter 11, policies which are held against key persons in the business or as part of a buy-sell agreement may be subject to treatment as assets by the court. If one partner dies during the process of a Chapter 11 bankruptcy, the court may seize the proceeds of the policy during the duration of the case.
One other important consideration for those filing bankruptcy is whether to purchase life insurance after the bankruptcy is discharged. The answer to this question is almost always “yes.” Once you have filed bankruptcy, your debts are discharged, but your assets are often severely reduced.
If you were to die suddenly, would your family be able to afford to live in your home? If you have no savings, as is usually the case after bankruptcy, it is very important to provide an instant estate for your family in case of your death. At no time, perhaps, is this more important than just after a bankruptcy.
Many people end up in bankruptcy because of misguided financial planning. While circumstances can definitely cause unforeseen expenses, it is important to budget enough to have life insurance coverage for your family.
This should be a top priority for anyone who has filed bankruptcy or is considering it. Met Life, Prudential, and New York Life are companies which offer very reasonable term policies, and almost anyone can find the small amount needed each month to insure loved ones from financial ruin.
