When you file for bankruptcy, you can protect the property that you need to live, such as furnishings, clothing, a modest car, and some portion of home equity. In some cases, you can protect the value of a life insurance policy or the money you receive as a beneficiary under another person’s policy. But it will depend on a number of factors.

Types of Life Insurance Policies

The two main types of policies that people own are whole life and term life insurance. A term life policy doesn’t have a cash value but pays a set amount to the named beneficiary. It would be unusual to need to worry about a term policy that you own in bankruptcy.

That’s not the case for a whole life policy, however. It accumulates cash value over time and as a result, you can take a loan against it, or you can cash it in and get money. Because of its value to you, you’ll need to determine whether you can protect it in your case (more below). You’ll also need to determine whether you can protect funds that you receive as a beneficiary of a policy.

Protecting a Life Insurance Policy in Bankruptcy

Each state decides the property its citizens can keep in bankruptcy. You can find out whether you can protect (exempt) your life insurance policy by reviewing your state’s exemption statutes. Also, some states allow citizens to choose between the state exemptions or the federal exemption scheme.

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. Keep in mind that your term policy won’t have any value, so what you’ll likely be protecting will be the cash value of a whole life policy.

If you don’t have a life insurance exemption available, your state might have a wildcard exemption that you can use to protect any property of your choosing. The wildcard can be used with another exemption if the life insurance exemption is not enough to protect the policy.

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 you file your bankruptcy case, the money will be treated as a cash asset. The fact that it came from a life insurance policy won’t matter. You will need to look to the exemptions that apply in your case for a cash exemption (such exemptions are rare), or you can 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 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 are not.
• Received within 180 days of filing. 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 and Chapter 13 Bankruptcy

You’ll also need to consider the type of bankruptcy chapter that you file.

• Chapter 7 bankruptcy. If you can exempt the life insurance asset, the trustee can’t take it.
• Chapter 13 bankruptcy. You’ll have to pay any nonexempt value to your creditors as part of your Chapter 13 repayment plan. Also, all assets received during the plan are assets of the estate but different courts have different rules about whether you’ll pay the funds to your unsecured creditors. You’ll want to discuss your options with your attorney.

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