How would declaring bankruptcy affecting my life insurance policy?
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Asked February 10, 2014
The type of life insurance policy you have will partially determine whether it is vulnerable to creditors if you file a bankruptcy. How long the policy has been active is another consideration. Some states will give you a choice between state and federal bankruptcy, and that can have a big impact on how your life insurance policies are treated, as well.
Most term life policies are exempt from bankruptcy. Since the policy does not have a cash value, it is considered primarily a contract for your survivors, not a personal financial tool. In other words, you cannot personally profit from the policy, or use it is a way to put exempt money aside, so it is considered exempt.
The catch, even for a term life policy, is that most states will require the policy to be effect for a minimum of 1 to 2 years before the bankruptcy filing began. This demonstrates an interest in the policy over an extended period of time. This law is typically applied to all types of life insurance policies, not term policies alone.
Final Expense insurance is a special type of permanent life insurance that does not have a cash value. Final Expense insurance, like a term life policy, is designed for use after your demise, and has no cash value while you are living. This makes it exempt from creditors as long as the policy is at least a year older than the bankruptcy filing.
The cash value in your life insurance policies may be subject to creditors. Under many state laws, the entire cash value, because it is a type of savings, is liable to inclusion in your assets when you file bankruptcy. If the policy pays dividends as well as a cash value, those earnings are part of your assets, as well, and will be considered as secondary income.
If you are given a choice between filing under state or federal law, the federal regulations will allow you to retain a portion of the cash value in your policies. Under federal law, you can protect up to $10,775 on personal life insurance policies, and couples filing joint bankruptcy may claim double that amount. Since states are allowed to replace federal law with their own regulations, this option may not be available in your state.
Bankruptcy is a serious credit event. Consult a professional before you file bankruptcy and discuss the full ramifications of what you are considering. Since a bankruptcy stays on your credit for up to 7 years, filing could mean that you are unable to take out loans, purchase insurance policies, and other credit-related functions. For example, your existing insurance rates will increase, and a severe drop in your credit score could lead to future denials or being left with only high-risk insurers to choose from.
Answered February 10, 2014 by Anonymous