Will I Lose My Life Insurance Policy If I File for Bankruptcy?

The United States Congress recognizes the importance of life insurance to families and ongoing financial stability. To encourage family planning, life insurance is afforded tax benefits as well as some exemptions from creditors. With a life insurance policy, in return for your payments, your insurance company will provide your beneficiaries with a death benefit in the event of your passing.  As of 2020, about 57% of Americans report having a life insurance policy.  But what happens if you run into serious financial hardship?  If you file for Chapter 7 or Chapter 13 bankruptcy, will you lose your life insurance benefits to creditors?  Our Princeton bankruptcy lawyers explain.

Are Life Insurance Proceeds Exempt in Bankruptcy?

All of a debtor’s possessions, including real and personal property, cash, and other assets with a monetary value, are considered the “bankruptcy estate.” The “bankruptcy estate” is available to be liquidated in Chapter 7 or used to determine the amount paid in Chapter 13, to satisfy a debtor’s financial obligations. Fortunately, both the Bankruptcy Code and state law permits a debtor to protect a portion of their property. Known as exemptions, these provisions are specific and limited.

Each asset a debtor owns is listed in “Schedule B” of their bankruptcy filing. Then, under “Schedule C,” each asset is exempted to the extent allowed by law, including life insurance policies. Our experienced bankruptcy attorneys will thoroughly review a debtor’s assets and exempt them as much as possible. Once completed, all of the debtor’s assets are categorized as either “exempt” or “non-exempt.”

Exempt items enjoy partial to full protection from creditors, with the extent of protection depending on where you are located and which set of exemptions you elect to use.  In contrast, non-exempt items are not exempt from the bankruptcy estate, and therefore may be pursued by creditors to help satisfy your debt obligations.

As mentioned above, exemptions can vary dramatically depending on where you live.  Some exemptions which exist in one state do not even exist in other states.  New Jersey and Pennsylvania debtors may choose between using the exemptions which correspond to their state, and the nationwide federal exemptions. However, you are not permitted to split the exemptions. If you choose to protect specific property through the federal exemptions, you are not permitted to use the state exemptions for another asset – it is one or the other. This can be a difficult decision as each group of exemptions offers varying benefits. Our attorney will review your assets with you to determine which set is the most beneficial.

The current life insurance bankruptcy exemptions are as follows:

• Pennsylvania — Proceeds from life insurance may be exempted if the beneficiary is the decedent’s child, spouse, or a dependent relative.

• New Jersey — Proceeds from life insurance are exempt if the policy expressly prohibits proceeds from being used to satisfy the beneficiary’s creditors.  Additionally, proceeds which go toward individuals other than the insured person are exempt from the creditors of both the beneficiary and the insured person.  You can also exempt proceeds related to disability provisions in your policy.

• Federal — Life insurance proceeds can be exempted if they have not matured, with the exception of credit life insurance (i.e. a policy which is meant to pay the borrower’s debts in the event of death). Furthermore, under the federal personal property exemptions, you can exempt up to $12,625 in the loan value of your policy.

It’s also important to talk about the 180-day rule which applies to Chapter 7 bankruptcy cases.  If you inherit life insurance within 180 days of filing for bankruptcy, that inheritance will be folded into the bankruptcy estate, and anything which is non-exempt may be vulnerable to the trustee and your creditors.  However, if you do not inherit insurance until after 180 days have already passed from the time of your filing, the insurance proceeds will not be added to the bankruptcy estate.

Whole Life Insurance vs. Term Life Insurance in Bankruptcy

Exactly how your insurance policy will be treated in your bankruptcy depends on the type of policy you have. Typically, life insurance is either term or whole life. There is a significant difference between whole life and term life insurance policies. Term life is strictly insurance, paying out upon the death of the insured. On the other hand, whole life insurance is more of an investment, with a cash value.

A term life insurance has a limited life span. You will pay a premium for a set period of time. If the insured is still alive at the end of the term, then the policy expires. For bankruptcy purposes, a term life policy has no financial value – though it still must be listed as an asset.

Whole life insurance functions very differently. While there is still an insurance component that will provide proceeds in the event of a death, there is also an investment portion. Part of your monthly premium is invested, building up a cash value. Should the insured survive the term of the insurance policy, the accrued proceeds are distributed to the insured. Therefore, a whole life insurance policy is an asset with monetary value in a debtor’s bankruptcy.

The federal exemptions, as seen above, allow a debtor to exempt up to $12,625 of the cash value of a whole life insurance policy. The chapter of bankruptcy will determine what a trustee will do if there is any non-exempt equity in a whole life insurance policy.

If the “cash surrender value” (CSV) of your policy is $20,000, then, under the federal exemptions, there is $7,375 of non-exempt equity. In Chapter 7, the trustee will most likely require you to liquidate the entire policy and turnover the $7,375 to distribute to your creditors.

If you filed Chapter 13, then you will have to allocate at least $7,375 in your bankruptcy plan to unsecured creditors. This amount would be in addition to any secured creditors you would be paying, such as your mortgage company. Often, a debtor will determine the chapter of bankruptcy based on their non-exempt equity. It is essential to have the assistance of our seasoned bankruptcy attorney to help make informed decisions regarding the protection of your assets, including your insurance policies.

You Must List Your Assets — Even if They’re Exempt

Whether you have a term life policy or a whole life policy is another important point of consideration. When you file for bankruptcy, you have to list all of your assets.  In fact, if you are caught attempting to conceal assets in an attempt to hide them from your creditors, your case may be dismissed — not to mention the fact that you could find yourself being charged with fraud, which could result in substantial fines or imprisonment.

Despite the aforementioned life insurance exemptions, if you fail to list the CSV (Cash Surrender Value) of your whole life policy, it may be taken and distributed by the trustee assigned to handle your case.  While term life policies do not have a CSV like whole life policies, proceeds could also be claimed by the trustee if you were to pass away after the completion of your bankruptcy case and you failed to list your policy.

The bottom line is that, even if you are confident the proceeds of your policy would be exempt from the bankruptcy estate, your assets must still be properly disclosed and documented — or else you risk losing more than you have to.  When the time comes to list your assets, insurance should be documented on “Schedule B,” which is used for personal property.  In the “Type of Property” column, you will see insurance noted at entry number nine (“Interests in insurance policies”).  Filers are instructed to “Name insurance company of each policy and itemize surrender or refund value of each.” Additionally, if you have a whole life policy, you will typically have to provide a copy of the policy and proof of its current cash surrender value.

Life Insurance Policies After Bankruptcy

In addition to protecting your insurance policy during your bankruptcy, people wonder about the challenges of obtaining life insurance after bankruptcy. While no two cases are exactly the same and different factors will apply under different circumstances, getting life insurance post-bankruptcy can be difficult.

The negative impact filing for bankruptcy has will diminish over time. If you have recently received a discharge, you will probably face more hurdles than someone whose discharge is a few years old. Also, the chapter you file for will affect your ability to obtain a new policy.

Typically, if you have filed for Chapter 7, you will be required to wait at least a year before most insurance companies will approve your application. Sometimes the wait is two years from the date of your discharge. Because Chapter 13 is a reorganization, necessitating payments to your creditors, there is typically no restriction to being approved for a new life insurance policy during your bankruptcy proceeding. However, you can expect to be offered higher premiums than someone who is not currently in bankruptcy. While this sounds like a reason not to file for bankruptcy, do not let it dissuade you if you are currently deep in debt. Insurance companies use your credit score when evaluating risk, so it is likely that filing for bankruptcy would improve your situation in time.

Pennsylvania Bankruptcy Lawyers Offering Free Consultations

One of the things that prevent people from considering filing for bankruptcy when they are struggling financially is the fear that they will lose their home, car, or other possessions. Included in that extended list of valuable assets is their life insurance policy they intend for the benefit of their family. Fortunately, much of that fear is ungrounded, including losing their life insurance. Our attorneys have over two decades of experience guiding individuals through difficult economic times. At Young, Marr, Mallis & Associates, our goal is to alleviate your financial stress while protecting your property, helping you get the fresh start you deserve. Don’t wait too long to file bankruptcy, set up a free and confidential case evaluation with our New Jersey bankruptcy attorneys, call Young, Marr, Mallis & Associates at (609) 755-3115 in New Jersey or (215) 701-6519 in Pennsylvania today.