Life Insurance in Bankruptcy: What You Can Keep and How to Protect It

Life insurance can affect your bankruptcy case if your policy has cash value. You could also be affected if you receive a payout after someone passes away.

Whether you can keep the policy or the money depends on several factors. Your state’s exemption laws matter. The type of policy matters. When the money becomes yours matters too.

Some life insurance is fully protected in bankruptcy. Other parts might count as assets the trustee can use to repay creditors.

Understanding what kind of policy you have is the first step. If you’re not sure how this applies to your situation, consider speaking with a bankruptcy attorney for free.

How Life Insurance Can Affect Bankruptcy

When you file for bankruptcy, the court doesn’t just look at your debts. It also looks at what you own.

Your property, your money, and any other assets become part of your case. Life insurance policies are included.

All of this becomes part of your bankruptcy estate. That’s a legal term for everything you legally own when you file.

Why does this matter? Because the bankruptcy trustee reviews your bankruptcy estate to see if there’s anything they can use. If something you own has value, it could affect your case.

A life insurance policy with cash savings counts as an asset. So does a payout you recently received.

Two Common Ways Life Insurance Comes Into Play

• You own a life insurance policy that has cash value
• You’re the beneficiary of a policy, and the insured person passes away before or shortly after you file

To figure out if life insurance might impact your bankruptcy case, you need to understand your policy. Know what kind you have and whether it has any current value.

Key Terms To Know

Every life insurance policy involves three main people:

• Owner: The person who controls the policy and can make changes
• Insured: The person whose life is covered
• Beneficiary: The person who gets the payout when the insured dies

You might be one or more of these people on a policy. For example, you might own a policy that covers your life and names someone else as the beneficiary.

Another important term is maturity. A life insurance policy is matured when it pays out. That usually happens because the insured has passed away. Until then, it’s unmatured.

What Happens to a Life Insurance Policy in Bankruptcy?

Unmatured life insurance policies haven’t paid out yet. They’re treated differently depending on whether they have a cash value.

Here’s a quick look at the different types of life insurance policies:

Policies Without Cash Value (Term Life Insurance)

Term life insurance is the most common example of a policy without cash value. It doesn’t build up any savings over time.

It just provides a payout if the insured dies during the policy period.

Even though term policies don’t have cash value, you still need to list them. They’re usually fully protected under federal and most state exemption laws.

They don’t have any financial value during your lifetime. That makes them safe from creditors in bankruptcy.

Policies With Cash Value

Some policies have both an insurance component and a savings component. These include:

• Whole life
• Universal life
• Variable or flexible life

Over time, these policies can build up cash value. You can borrow against this money or cash it out.

It’s considered an asset, so it’s part of your bankruptcy estate.

You can check with your insurance company to find out how much cash value your policy has. Even if your policy could have a cash value someday, it might be worth $0 right now. That’s especially true if you recently borrowed against it.

Can You Keep a Policy With Cash Value?

Many people are able to keep their life insurance policy. That’s true even if it has cash value.

But this depends on:

• How much cash value the policy has
• Which exemptions you’re using (federal or state)
• Who the insured person is

Under the federal exemption laws, you can protect up to $16,850 in cash value. You must be the policy owner. The insured must be either you or someone who can claim you as a dependent.

If the cash value is more than $16,850, you may be able to use the federal wildcard exemption. The federal wildcard exemption gives you an additional $1,675. You can get up to $15,800 more if you don’t use the full homestead exemption.

Many states have their own exemption laws that work differently. Not all states let you choose between federal and state exemptions.

What if You Receive Life Insurance Money After Someone Dies?

If someone passes away and you receive life insurance money as a beneficiary, that payout might affect your bankruptcy case.

The timing matters a lot here.

If you become entitled to life insurance proceeds within 180 days after filing your bankruptcy case, the money is considered part of your bankruptcy estate.

The trustee could use it to pay your creditors unless you can claim it as exempt.

If the insured person dies more than 180 days after you filed, the money you receive is not part of your bankruptcy estate. The trustee can’t take it.

Even if you haven’t gotten the money yet, the key question is when you became entitled to receive it. That’s usually the date the insured person passed away.

Can You Protect Life Insurance Proceeds?

Under the federal exemption laws, life insurance money you receive as a beneficiary is fully exempt. But two things must both be true:

The person who died could have claimed you as a dependent.

The money is reasonably necessary to support you or your dependents.

What counts as “reasonably necessary” depends on the bankruptcy judge and your situation. You might have to show your monthly expenses. You might need to explain why you need the money.

Some state exemptions also protect life insurance proceeds, but often with restrictions. For example, some only protect proceeds from group policies. Others only protect policies with specific beneficiaries.

If your state doesn’t offer a specific exemption, you might still be able to protect the money. You could use a wildcard or personal property exemption.

If you receive life insurance money after filing your case, notify your bankruptcy trustee. Failing to do this can lead to serious consequences. You could face accusations of bankruptcy fraud.

Can You Get Life Insurance After Bankruptcy?

Filing for bankruptcy doesn’t permanently disqualify you from purchasing life insurance. But it can make the process more difficult in the short term.

You may experience:

• Waiting periods
• Higher premiums
• Negative credit score impact

Many insurers require a waiting period after a bankruptcy discharge before approving a new application. For Chapter 7 bankruptcy, this is often 1-2 years after your case is closed.

For Chapter 13, you may be able to apply sooner. Sometimes you can apply even during your repayment plan. But approval can still be more challenging.

Insurers may view recent bankruptcy as a sign of increased financial risk. Your premiums may be higher. Your policy options may be limited.

Your credit score and overall financial profile are important factors in underwriting. As you rebuild your credit and demonstrate financial stability, your options will improve. Your rates are likely to get better too.

Tips for Keeping or Obtaining Life Insurance After Bankruptcy

If you were able to keep your life insurance policy through bankruptcy, maintain your premium payments. Review your beneficiaries. Monitor your policy status.

If you miss payments, you risk losing coverage. Staying in touch with your insurer can help ensure you stay in good standing.

If You’re Trying to Get a Policy After Bankruptcy

Here are four tips to follow:

1. Shop around: Different insurers have different guidelines. Compare multiple companies to find the best terms.
2. Be up front: Disclose your bankruptcy honestly on your application. Insurers will check your credit history. Transparency is key.
3. Focus on term life: If affordability is a concern, consider starting with a term life policy. These are usually less expensive and easier to qualify for than permanent policies.
4. Reapply later: As your credit improves and more time passes since your bankruptcy, you may qualify for better rates. Review your policy options periodically.