How Personal Bankruptcy Impacts Your Life Insurance Policy

Filing for bankruptcy is usually person's worstexemptions under federal or state law, but not
nightmare, but when it comes to protecting yourboth. Explains Stevick, 34 states like Illinois, New
assets (including the value of your life insuranceYork, California and Florida have "opted out" of
policy), information is key.the federal law and have inducted their own state
A life insurance policy is considered valuableprotections.
property, which means creditors may attempt toSixteen "choice states" - including Texas - allow
"acquire an interest in the policy's values," but alldebtors to choose between federal and state
states and the federal government have "enactedexemptions. Under federal exemptions, one can
legislation providing protections for life insuranceprotect up to $10,775 of a life insurance policy's
against the claims of creditors," says Glenn E.cash value (doubled for married couples). Also, in
Stevick, Jr., a professor with The Americansome states the unused portion of the
College.homestead exemption (real and personal
Here's some basics you should know when itproperty) may be used for other property,
comes to bankruptcy and how it affects your lifeincluding the cash value from a life insurance
insurance policy.policy. Some states require the policy to be in
First, more people file for bankruptcy than youforce for one to two years for protection under
might imagine. With the latest economic downturna state exemption, to prevent using life insurance
and mounting bills, the current bankruptcy-filingas a shelter in bankruptcy planning.
rate is at a 5-year high, according to recent dataIn order to be eligible to file bankruptcy under
released by Automated Access to Courtstate protections, you must be considered a
Electronic Records (AACER). What's more, theresident and live in a state for 24 months.
American Journal of Medicine reported that moreIn Illinois, whole life insurance is exempted from
than 1.5 million people filed bankruptcy last year,creditors to the extent that it is necessary to
60 percent of those filings were the direct resultsupport a dependent (a spouse and dependent
of medical bills.children), but the legal interpretation is up to your
The American Journal of Medicine, for example,bankruptcy judge.
found that 1 in 25 people in the Bay Area haveWhen you file your bankruptcy petition you'll
filed for bankruptcy last year, says bankruptcytypically include a schedule or list of your exempt
attorney, Jeena Cho of San Francisco-based JCproperty, which can include your life insurance
Law Group.policy.
"It's like the dirty little secret," Cho says. "TwoRon Caruthers, a financial planner, who helps
things that we don't talk about are death andindividuals pay for college with over funded life
money. When people start talking about theirinsurance policies, says Florida, is the most
financial issues, they find there are plenty ofdebtor-friendly state to file bankruptcy since it
people in the same boat."has a strong homestead exemption. Another
There are two types of bankruptcy for individuals:debtor-friendly state is Texas, which allows large
Chapter 7 and Chapter 13.exemptions for cattle and homesteads.
Chapter 13 is where you can hold on to your"It's why O.J. Simpson took all his assets and
assets and aren't at risk for losing property, butmoved to Florida and put them into life insurance
you must repay some of the debt over a threeand a home, since they couldn't touch either when
to five year period. If your cash value for lifehe filed for bankruptcy," Caruthers says.
insurance is worth more than the exemption inOn the opposite end of the spectrum is Arizona.
your state, then consider filing Chapter 13 toCaruthers says Arizona is the most
protect your assets, Cho recommends.creditor-friendly state.
If you pass a means test and can file a ChapterKeep in mind that all 50 states are different when
7, you must liquidate your possessions andit comes to bankruptcy protections, so it's best
assets, which typically takes four months. It alsoto contact a financial planner or bankruptcy
means your life insurance policy could be affected.lawyer in that state to learn more.
Cho says one of the worst things someone canHere are some suggestions for what to look out
do is liquidate their assets and start borrowingfor before you file for bankruptcy.
money from their life insurance and retirementDeath benefits: How much of the proceeds in the
funds, which are almost always protected indeath benefit are protected against creditors
bankruptcy.(some state have a dollar amount like $5,000 or
"People start taking whatever little money they$10,000 other states allow the entire amount.)
have to see if they could get out of debt byIt is important to review how much of your life
re-paying it," Cho says. "I see people drain theirinsurance policy is protected. For example, in
$40,000 retirement fund for $100,000 in creditCalifornia an unmatured policy is exempt up to
card debt. They start selling their cars and homes$11,475 for homeowners filing jointly or
without an exit strategy. The game plan is toseparately under code 704 (c ), non-home
keep as much as possible."owners file under 703.140 (b) which allows for up
Also, make sure you disclose everything includingto $11,800. Say your life insurance policy exceeds
the current, accurate cash value of your whole$11,475 than you can use the wild card
life insurance policy. Some people don't "becauseexemption of $23,250, which can be applied in
they are afraid to and end up losing it becausepart or in whole to the policy as well.
they failed to disclose it's true value," says DavidLook up the exemption statistics where you do
Leibowitz, a bankruptcy lawyer for Lakelaw inbusiness because every state is different. Pay
Chicago, Ill.close attention to differences in state and federal
Under state and federal bankruptcy law, anlaws and what parties are protected - the policy
individual filing for bankruptcy may electowner, beneficiaries, etc.