Can the Bankruptcy Court Take Life Insurance Funds?

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, try our quick ten-question bankruptcy quiz, and read our list of things you should know about bankruptcy.

Life Insurance Funds in Bankruptcy

It's essential to understand how the two primary life insurance policies differ before filing for bankruptcy.

• A term life policy doesn't have a cash value but pays a set amount to the named beneficiary.
• A whole life policy accumulates cash value over time, so you can take a loan against it or cash it in for money.

It would be unusual to worry about a term policy in bankruptcy. However, whole life policies are different because of their value. You'll need to determine whether you can protect a whole life policy's cash value and any funds received as a beneficiary in bankruptcy.

How to Protect Whole Life Insurance Funds in Bankruptcy

You must report all of your property on bankruptcy forms, including the value of life insurance policies and funds received as a beneficiary. You won't lose the property in bankruptcy as long as an exemption covers it.

Each state decides what its citizens can exempt, so you'll start by reviewing your state's bankruptcy exemption statutes. Some states let filers choose between the state exemptions and the federal exemption scheme. You'd pick the system that would protect the most assets.

Many states have exemptions that will cover a life insurance policy, but they each have different requirements. You'll want to review your state statute carefully. If your state doesn't have a specific exemption, look for a wildcard exemption that you can use to protect any property of your choosing.

Protecting Life Insurance Proceeds in Bankruptcy

The bankruptcy court will look to the date you received the life insurance funds when determining the exemption status.

• Received funds before filing. If you receive proceeds before filing your bankruptcy case, the money will be a cash asset. The fact that it came from a life insurance policy won't matter. Look for a cash exemption (they're rare), or use a wildcard exemption.
• Right to receive funds before filing. If someone died before you filed your bankruptcy case but you haven't received the life insurance proceeds yet, the right to receive the money is an asset of your bankruptcy estate. Look for an exemption for life insurance proceeds. The type of insurance policy is important. For example, in Ohio, proceeds of a group policy are exempt, but private policy proceeds are not.
• Received within 180 days of filing. The critical date is the insured's date of death, not the date you receive the funds. If someone dies a month after you file, the life insurance proceeds will be the property of your estate because the death was within 180 days of your filing. You must notify the court and claim appropriate exemptions to protect the funds.

Navigating Your Bankruptcy Case

Bankruptcy is an unusual area of law because it's essentially a qualification process. The laws provide instructions for completing a 50- to 60-page bankruptcy petition, and because all rules apply in every case, you can't skip a step.

The forms and resources below will help you find more information. Also, you can use this list of Chapter 7 and 13 bankruptcy forms to see where this topic falls. And this handy bankruptcy document checklist will help you gather the things you'll need to complete the petition.

Need More Info?

We want to help you find the answers you need. Go to TheBankruptcySite for more easy-to-understand bankruptcy articles, or consider buying a self-help book like The New Bankruptcy by Attorney Cara O'Neill.

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 consulting with a local bankruptcy lawyer.