Published by Mark

Life Insurance Ranks In Bankruptcy

November 17, 2008 at 4:04 am

Even though I’m a bankruptcy attorney only in the state of Indiana, in order to stay current on bankruptcy matters, I like to read up on bankruptcy court cases from other states. One recent case that was appealed to a higher court had to do with life insurance policies. Most of us don’t think of our life insurance policies as property, but if those policies have a cash value, (whole life or universal life policies usually have cash values, term policies do not) then they are, in fact, a form of property.

Well, the situation I was reading about involved a man and wife who had both filed bankruptcy. Each of them owned a life insurance policy with the other being the beneficiary (meaning the person who receives the money when the insured dies). When the bankruptcy court was looking at the couple’s assets to determine what money they had to pay creditors, a question came up about the cash value of the life insurance policies, and whether their insurance should be cancelled and the cash value used towards paying off the couple’s debts. The final ruling was that the insurance cash values were “exempt”. That meant the couple could keep their policies without needing to use the cash value money towards paying creditors. Life insurance for the purpose of taking care of family members was considered “sacred” by the court.

Life insurance cash values are not the only assets that are exempt in bankruptcy. In Money Double-Exempt in 401K, I explained that, under the newest version of Indiana bankruptcy law (I helped write the exemption portion of this law!), money in 401K retirement plans and even money in IRAs (Individual Retirement Accounts) is protected from creditors. That’s because those accounts are meant to help provide financial security in retirement. That means, even if someone gets behind financially and is forced to file bankruptcy, it’s considered of crucial importance to preserve his or her retirement money.

Besides 401K money and life insurance cash value, there’s a third category of assets that enjoys special protection under bankruptcy law. In 5+2+9 Adds Up To Protection In Bankruptcy, I mentioned that, in order to encourage savings to educate our young, the law says that money that’s been in a 529 College Savings Plan or Coverdell Education IRA account for longer than two years is exempt from creditors.

Every legal system is based on a series of beliefs. Our society believes we need to encourage savings to help educate our young, and encourage saving towards retirement security for our older citizens. Then, if things fall apart for some people in between – that’s where the bankruptcy safety net goes into action.

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