Life Insurance and Bankruptcy: Is my policy protected from creditors?

Form titled Chapter 13 Bankruptcy

Life insurance helps provide financial security for your family in the event of your death. But what happens when your financial situation is precarious and you’ve had to file bankruptcy? Can you still purchase insurance? Will your insurance’s death benefit be seized to pay your creditors before your family can use it? Read on to learn how bankruptcy can impact not just your eligibility for insurance, but the money that comes from your policy.

Types of Bankruptcy

There are several types of bankruptcy relief that are available to individuals. The type of bankruptcy you choose depends on several factors, including:

  • Your current income
  • Whether or not you have assets available to repay debt
  • If you have available assets, whether you want to liquidate those assets for debt repayment or reorganize your debt without sacrificing assets. 

The two most common types of bankruptcy for individuals are:

  1. Chapter 7 bankruptcy, which involves liquidating assets to pay your creditors. Unsecured debt (such as credit cards or medical bills) are erased. You may not be required to sell your home, car or retirement accounts, but there are no guarantees. Chapter 7 bankruptcies are usually filed when you don’t own property with enough value to sell in order to help settle the debt.
  2. Chapter 13 bankruptcy involves a court-approved repayment plan that reorganizes your debt. You can file for Chapter 13 bankruptcy if you have less than $419,275 in unsecured debt and less than $1,257,850 in secured debt.1 This type of bankruptcy does not require you to liquidate your assets, which allows you to pay debt back within three to five years.

State and Federal Life Insurance Bankruptcy Exemptions

Bankruptcy exemptions exist on two levels: state and federal. These exemptions can impact several assets but they allow you to protect the cash value of your life insurance policy. You are eligible for an exemption if you’re the owner of a life insurance policy and the insured party is you, your spouse or another person that you are financially dependent upon.

Federal and state exemptions are different. The federal Bankruptcy Code protects the face amount of your unmatched life insurance policy and up to $12,625 in interest in accrued dividends, interest or loan value. Some states, however, don’t let you choose the federal option. In these cases the state exemption is the only choice. However, state exemptions tend to be more generous because they protect the cash values and death benefits of insurance policies from creditors. Each state’s exemptions differ, so it’s important to know the law prior to filing for bankruptcy.2

Am I eligible for life insurance if I file for bankruptcy?

Bankruptcy is a risk factor for insurance companies because it suggests you might not be able to consistently pay your future insurance premiums.

Chapter 7 bankruptcy and bankruptcy proceedings that haven’t been discharged (resolved) more than two years ago make buying insurance difficult. If you’ve filed for Chapter 13 bankruptcy, you may have some options.

All insurance companies treat bankruptcy differently, which is why it’s important to shop for coverage with multiple carriers at one time. In addition to the competitive rates you can get when shopping around, you’ll get a better sense of requirements for financial stability from each insurance company. If you have questions about how past or present bankruptcies can impact an insurance company’s outlook on your risk, SelectQuote can help.

How Bankruptcy Impacts a Term Life Insurance Policy

Creditors are usually only interested in matured assets, so bankruptcy does not typically impact an existing term life insurance policy because these policies don’t mature until the benefactor’s death. Term life insurance doesn’t accrue a cash value, which makes it essentially useless for these entities to go after. While you are still required to list your term life insurance policy on any bankruptcy forms, it’s not considered an asset.

How Bankruptcy Impacts a Whole Life Insurance Policy

Whole life insurance is a different story, however. Whole life insurance policies accrue cash value over time and offer flexibility to borrow against that value. Federal law considers this value an asset, which makes it part of the bankruptcy estate. The only way to avoid having it seized to settle debt is to follow state and federal law and attempt to declare it exempt.

Does bankruptcy impact my life insurance premiums?

A bankruptcy on your record could lead to higher life insurance premiums because a stable financial background is part of the calculations insurance companies make when determining your rates. You’ll need to justify your level of life insurance coverage, and that means proving that you’ve established long-term financial stability via income and assets.

If you’re healthy and a nonsmoker without any dangerous hobbies or professions, you’ll probably be able to get a life insurance classification of Preferred. While this is a step below Preferred Plus—and thus subject to slightly higher premiums—your health history won’t impact you too much. A good rule to remember is that the farther you’re out from the completion of your bankruptcy case, the lower your life insurance rates will likely be.

Receiving Life Insurance Proceeds During a Bankruptcy Case

As we’ve stated above, the cash value of your whole life insurance policy may be seized as an asset to pay off your creditors. The death benefit, however, cannot be seized because it’s often exempt from liquidation. If you die while under bankruptcy and your insurance policy is in force, your beneficiaries won’t be required to use it to pay your debts. The only time it can be forfeited to pay your creditors is if it goes directly to your estate rather than a beneficiary.

What if you’re under bankruptcy and are the beneficiary of a life insurance policy? If you’ve received the funds prior to filing for bankruptcy, it will be counted as a cash asset. If someone died prior to filing your bankruptcy and you have yet to receive the money, that right is considered an asset of your bankruptcy estate. In this case, seek out an exemption for life insurance proceeds.

If someone dies within 180 days of filing for your bankruptcy proceedings, the proceeds that you are due are considered property of your estate. You have to notify the court and take exemptions.3

It’s important to have all the information about life insurance and bankruptcy–whether you’ve recently resolved your bankruptcy case and have life insurance questions or you want to know more about how bankruptcy status impacts your life insurance policy’s death benefit. SelectQuote can help answer your questions and help you find a life insurance policy after bankruptcy. Shop for coverage and compare rates from several different companies at once.

1 https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title11-section109&num=0&edition=prelim

2 https://www.nolo.com/legal-encyclopedia/bankruptcy-exemptions-state

3 https://www.thebankruptcysite.org/resources/can-the-bankruptcy-court-take-life-insurance-funds.html

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