Life insurance aims to protect your loved ones in the event of your untimely passing. Bankruptcy shields people from the financial distress of debt collection. Unfortunately, the former may be at risk when an individual files for the latter. Life insurance policies and distributions are assets. Those assets may or may not be exempt from bankruptcy.
As you continue reading, we’ll dive deeper into what happens to your life insurance if you go bankrupt.
Whole life insurance Vs. Term life insurance
The type of life insurance you have is relative when filing for bankruptcy. A whole life insurance policy counts as an investment because it has a cash value. Term life insurance does not carry a cash value. It still needs to be listed as an asset when filing for bankruptcy, but there’s nothing to distribute during the debt settlements negotiated by the bankruptcy trustee.
In a Chapter 7 bankruptcy, the filer’s assets or “property” are liquidated by the trustee. The proceeds are then distributed to creditors.
Chapter 13 does not require liquidation, but the total property value is used to calculate how much creditors will receive over time. In both cases, life insurance needs to be listed in the asset category of the bankruptcy filing.
Bankruptcy exemptions for life insurance
There are federal exemptions for life insurance in a bankruptcy filing and state exemptions. The choice of which will be used may not be up to the filer. Some states require the use of their exemption and others allow the bankruptcy filer to select which exemption is better for them. The amount that can be exempted varies by jurisdiction.
With whole life insurance, the exemption will be deducted from the policy’s cash surrender value (CSV). The bankruptcy filing will list the remaining portion of the CSV as a non-exempt asset. Depending on the type of bankruptcy, the filer may be required to liquidate the policy and surrender the remainder in cash to the trustee for distribution to creditors.
Getting life insurance after bankruptcy
Obtaining life insurance after filing for bankruptcy could be challenging. Most insurance companies won’t approve you for at least one year after filing Chapter 7. Restructuring debt with a Chapter 13 bankruptcy won’t necessarily prevent you from getting life insurance, but your premiums could be higher because you’re paying off overdue debt.
These restrictions are one of the reasons why life insurance exemption is in place. Losing it in bankruptcy could leave you without any coverage for an extended period. That’s something to consider before choosing which type of bankruptcy to file. Anything that requires a cancellation and liquidation of a life insurance policy could have long-term effects on the filer.
The Bottom Line
Filing for personal bankruptcy is a serious decision that should not be made without researching all the potential consequences. Losing your life insurance and/or not being able to get new life insurance coverage are two of those issues. Damaging your credit and your ability to make major purchases in the future is another. It’s best to consult with a bankruptcy attorney and carefully consider all other options before filing any type of bankruptcy.