Can the Bankruptcy Court Take Life Insurance Funds?

Learn whether you can protect a life insurance asset in bankruptcy.

By , Attorney · University of the Pacific McGeorge School of Law

It's possible to protect the value of a life insurance policy or money received as a beneficiary under another person's policy in bankruptcy. But it will depend on several factors, including:

  • the life insurance policy type, and
  • whether a bankruptcy exemption will protect the policy's value or proceeds.

If you'd like to learn more about what happens to debt and property in bankruptcy, be sure to check out the suggested resources at the end of the article.

Is Life Insurance Protected in Bankruptcy?

Most people don't file for bankruptcy after receiving a significant life insurance payout or if they suspect they might receive one. Why? Because people who have large amounts of money can pay their debts. They aren't bankrupt.

But it's possible you've already spent the lion's share of a death benefit or received a relatively small amount. In that case, bankruptcy might be an option, and the amount you'd keep would depend on the protections offered by your state.

To do this analysis, you'll need to know the following:

  • whether you must report the funds in your bankruptcy case, and
  • if you must report the life insurance payout, whether you can protect the money with a bankruptcy exemption.

We explain more below. If you'd like to learn about protecting a life insurance policy in bankruptcy, not a life insurance payout, skip to "How to Protect Term and Whole Life Policies in Bankruptcy."

Do I Have to Include Life Insurance Proceeds in Bankruptcy?

Yes. You'll report any amount of life insurance proceeds you have in your possession when filing for Chapters 7 and 13. You'll also disclose any funds you're owed but haven't yet received.

The life insurance reporting requirement is one of the few requirements that continues for 180 days after filing for Chapter 7 bankruptcy. If you come into life insurance money after filing your case, you'll inform the bankruptcy trustee by amending your bankruptcy petition.

Because life insurance payouts are a rich payment source for creditors, at the 341 meeting of creditors, the bankruptcy trustee appointed to your case will ask you whether you anticipate receiving insurance funds in the future. Learn about other 341 meeting questions.

If you receive life insurance funds during Chapter 13 bankruptcy, you'll want to talk with your lawyer about your options. Your lawyer can help you determine whether you can use the funds to pay your Chapter 13 payment plan early, dismiss your Chapter 13 case and repay debts outside of bankruptcy, or pursue another option.

Here's What You'll Report in Your Bankruptcy Petition

Term Life Insurance Policy

If you're paying for a term insurance policy, report it in your bankruptcy case. It's unlikely to have value.

Whole Life Insurance Policy

If you have a whole life insurance policy, report it in your bankruptcy case. Also, report the policy's cash value.

Life Insurance Proceeds

Report all life insurance proceeds you're entitled to or possess in your bankruptcy. You'll include funds received after cashing out a whole-life policy and death benefits from term and whole-life policies.

Will I Lose Life Insurance Funds I Disclose in Bankruptcy?

It's possible because cash assets aren't easy to protect in bankruptcy. You'll need a bankruptcy exemption covering the funds, and most states don't provide much protection for money, which life insurance proceeds essentially are.

Start by perusing your state's bankruptcy exemptions. Look for an exemption that covers cash or money in a bank account. If your state doesn't provide one, or if it isn't enough, a wildcard exemption allowing filers to protect any property they choose might be available.

But review wildcard exceptions carefully because some states exclude real estate and cash. Also, check the federal wildcard exemption amount if your state allows you to choose between the state and federal bankruptcy exemptions.

Finally, a few states let filers keep insurance proceeds when needed to maintain a home and other living expenses. It's a long shot, but worth checking. Ultimately, a local bankruptcy lawyer will be in the best position to help you protect your funds.

Will I Lose a Term or Whole Life Insurance Policy in Bankruptcy?

It's possible. You must disclose life insurance policies in bankruptcy and could lose a valuable policy if you can't protect it with a bankruptcy exemption. Knowing the type of policy will tell you a lot.

  • A term life policy pays a "death benefit" or a set amount to a beneficiary if the insured person dies. The policy won't be worth anything until it pays the death benefit.
  • A whole-life policy also pays a death benefit, but it has an additional feature of accumulating cash value over time, which allows you to take a loan against it or cash it in for money. A bankruptcy exemption must cover the value of a whole life policy for you to keep it.

You can almost certainly keep a term life insurance policy in bankruptcy because they aren't worth anything until they pay out. You can't cash out early and receive a portion of what you've paid.

By contrast, you'll need to determine the current value of the whole life policy and protect it with a bankruptcy exemption. Your bankruptcy trustee will know this and expect you to present proof of its worth before the 341 meeting of creditors.

Matured vs. Unmatured Life Insurance Policies in Bankruptcy

People in the insurance industry sometimes use terms like "matured" and "unmatured" when referring to insurance policies. But don't worry—they aren't terms you'll need to know or use in bankruptcy. Use the "Here's What You'll Report in Your Bankruptcy Petition" chart above to identify your bankruptcy responsibilities without using these terms.

Even though the terms aren't required, learning what they mean can be interesting.

  • An "unmatured" policy is active and in force. It hasn't paid a death benefit, expired, or cashed out, and coverage remains available.
  • A policy "matures" after paying a death benefit, expiring, or is redeemed for its cash value. Coverage is no longer available.

The following chart explains your responsibilities while incorporating the two terms. Essentially, it's the same information we provided in the "Here's What You'll Report in Your Bankruptcy Petition" chart above, so use whichever chart works best for you.

Unmatured Insurance Policy

Matured Insurance Policy

Term Life Insurance Policy

  • An unmatured term policy hasn't yet paid a death benefit but could because it remains in effect.
  • The policyholder or person paying for the policy would list it in bankruptcy, but it's unlikely to have value.
  • If the term policy matured after paying a death benefit or expiring, no one would report the policy. It's no longer in effect.
  • If the term policy matured after paying a death benefit, the "beneficiary" (person receiving the payout) would report the life insurance funds in bankruptcy, not the matured policy.

Whole Life Insurance Policy

  • An unmatured whole-life policy hasn't yet paid a death benefit or cash value but could because it remains in effect.
  • The policyholder would list it in bankruptcy along with its current cash value amount.
  • If the whole life policy matured after paying a death benefit or being cashed out, no one would report the policy. It's no longer in effect.
  • If the whole life policy matured after paying a death benefit, the beneficiary would report the life insurance funds in bankruptcy, not the matured policy.
  • If the whole life policy matured after the policyholder redeemed it for the cash value, the policyholder would report the funds in bankruptcy.

Can I Get Life Insurance After Filing for Bankruptcy?

Most people face challenges when purchasing a car, renting housing, and opening bank accounts after filing for bankruptcy. This occurs because a bankruptcy filing can appear on a credit report for up to ten years. Fortunately, the impact on credit approval and other financial transactions lessens with time, and most filers' credit improves in a year to four years.

If you have a term life insurance policy before filing for bankruptcy and continue paying the premiums, it's unlikely you'll lose the policy. However, a whole life policy might be dissolved if you lose it in bankruptcy.

In either case, you'll want to check with the coverage provider before filing for bankruptcy. Whether a bankruptcy will affect your ability to get a new life insurance policy after bankruptcy will depend on the provider's qualification requirements.

Learn about rebuilding credit after bankruptcy.

Navigating Your Bankruptcy Case

Bankruptcy is essentially a qualification process. The laws provide instructions for completing a 50- to 60-page bankruptcy petition, and because the rules apply to every case, you can't skip a step. We want to help.

Below is the bankruptcy form for this topic and other resources we think you'll enjoy. For more easy-to-understand articles, go to TheBankruptcySite.

More Bankruptcy Information

Bankruptcy Forms and Document Checklist

Schedule A/B: Property

Schedule C: The Property You Claim as Exempt

Chapters 7 and 13 Bankruptcy Form List

Bankruptcy Document Checklist

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When the Creditor Gets a Lien Against Your Property

We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.

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