What Happens to Life Insurance Policies During Bankruptcy?

As Philadelphia bankruptcy lawyers we hear a lot of fears and concerns from all kinds of clients. Some of them are about certain assets they gathered prior to filing.
And a life insurance policy can be a big asset. It’s natural to be concerned about it. And due to the prevalence of “grey” bankruptcies, these questions are coming up a lot lately. Older Americans are more likely to have them than younger ones.
Keep in mind we’re discussing your policies here, not a policy you’re receiving proceeds from because someone else has died. That’s a different post and a different issue. Here’s what you need to know.

Policy type matters.

The first question is whether you have a term life insurance policy or a whole one.

Term Life Insurance

Term life insurance policies aren’t worth anything until you die. And when you do, any monies received pass to your beneficiaries, not to you.
Thus, you won’t have to worry about losing it. You’ll just report your monthly premium payments along with all your other regular expenses.

Whole Life Insurance

Whole life policies are different. They do pay out to a beneficiary when you die, just like a term life policy does.
But they also gather cash value every year as you pay your premiums. Your beneficiaries do not receive this value. This money is tax deferred. Many people use these types of policies to generate retirement income.
Because it has cash value, this type of policy is an asset, and needs to be accounted for in your bankruptcy case.

How to Protect Yourself

Much depends on how much the policy is worth. If the cash surrender value of the policy is less than the exemptions allow for then it’s all protected.
If your policy is valuable enough to exceed the exemptions then protecting yourself means filing the right type of bankruptcy. You’ll file Chapter 13 instead of Chapter 7. You keep all your assets in Chapter 13 and pay your creditors on a court approved schedule. As long as you keep up with your plan you should be fine. If you end up converting your Chapter 13 to a Chapter 7 you may lose the ability to protect all of your whole life insurance policy’s cash value.
The laws governing life insurance exemptions are complex. It’s best to consult with an attorney before making any assumptions.
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