When you file bankruptcy, all of your property becomes property of the bankruptcy estate. This includes life insurance policies that you own, and money that you receive as a beneficiary under someone’s life insurance policy. The type of case you file, the type of insurance policy and when life insurance money is received are all important in determining if the court can take life insurance funds.
Life Insurance Policies That You Own
The two main types of life insurance policies that people own are whole life and term life. Term life policies are often purchased through work. Whole life policies are usually purchased directly and you pay the premium for the policy.
Term life policies do not have a cash value, but pay a set amount to the person you name as the beneficiary. Whole life policies accumulate cash value over time. You can take loans against them, and you can cash the policy in and get money.
A life insurance policy that you own is an asset of your bankruptcy case. A term life policy only has a value if you are the beneficiary and are entitled to receive money. The cash value of a whole life policy is an asset of your estate.
Exempting Cash Value In a Life Insurance Policy
Depending on where you live, you can protect certain property by using either federal or state exemptions. Exemptions let you take certain property and protect it from the trustee and your creditors. Your state law will determine what your exemptions are, or if you should use federal exemptions. Many states have an exemption specifically for life insurance that would cover the cash value of a life insurance policy. Some states limit it to policies where the beneficiary is the spouse or a dependent of the debtor.
If you don’t have a life insurance exemption available, you may be able to use a wildcard exemption to protect the cash value. A wildcard can be used to exempt any property and varies by state, or federal law. The wildcard can be used with another exemption if the life insurance exemption is not enough to protect the cash value.
Other Options To Protect Cash Value In Life Insurance
Depending on the exemption statute in your state, you may be able to protect the cash value by changing the beneficiary on your policy. For example, if your state protects cash value for dependents and spouses, if you have named your sister as the beneficiary, and you change it to your child, you could protect that cash value. It is important to discuss any changes with an attorney first because there may be timing issues to consider.
Life Insurance Proceeds
Actually Received Before Filing
If you are the beneficiary under someone’s life insurance policy, the money you receive when they die is called proceeds. If you receive proceeds before you file your bankruptcy case, the money will be treated as a cash asset. The fact that it came from a life insurance policy generally won’t matter. You will need to look to the exemptions that apply in your case for a cash exemption, or you can use a wildcard exemption.
You can also spend down the funds before you file your case. You can use the money on reasonable and necessary expenses such as car repairs, medical and dental expenses, home repairs, food, and clothing. You will want to work with an attorney to decide how to spend the money, and keep good records.
Right to Receive Before Filing
If someone died before your bankruptcy was filed, and you are going to receive proceeds but haven’t yet, the right to receive the money is an asset of your bankruptcy estate. Look at the exemptions that apply in your case for an exemption for life insurance proceeds. The type of insurance policy from which you are receiving proceeds is important. For example, in Ohio, proceeds of a group policy are exempt, but proceeds of a private policy aren’t. If there is no proceeds exemption, you can still use the wildcard exemption. Or, you may want to wait to file your case until the proceeds are received and spent down.
Received Within 180 Days of Filing
The bankruptcy estate includes life insurance proceeds received within 180 days of filing your case. The important date is the date of death of the insured, not the date that you receive the funds. If someone dies a month after you file your case, the life insurance proceeds that you are to receive are property of your estate, since the death was within 180 days of your filing. You must notify the court and take appropriate exemptions to protect the funds.
Chapter 7 versus Chapter 13
In a Chapter 7, if you can exempt the asset, the trustee can’t take it. This is true for either the cash value or proceeds.
In a Chapter 13, any non-exempt cash value or life insurance proceeds is included in the calculation of what must be paid to your unsecured creditors. A large non-exempt asset could mean that you can’t afford the Chapter 13 plan payment.
In Chapter 13, all assets received during the plan are assets of the estate. Different courts have different rules for whether non-exempt, post-petition assets have to be paid into the plan. Some courts take the position that it is bad faith not to include the value of life insurance proceeds received post-petition in what you pay to your unsecured creditors. It is important to discuss your options with your attorney. It may be possible to ask the court to retain some of the funds and pay some to your creditors.