Compared to your home, car or retirement plan, a life insurance policy is often not your most critical asset, or first concern if you file bankruptcy. Unless something happens to you and you have dependents.
Where you live can be important in this regard because exemptions are complex and usually local. Indiana, like many states, has an exemption for life insurance. But, like some states, you have to be careful how you’ve set up your insurance contract to keep the protection in bankruptcy.
In Indiana, it appears your insurance beneficiary designation determines if the insurance is exempt or not. For example, if your child or spouse is the beneficiary, you’re probably in the clear. But if your beneficiary is not your dependent, you may lose the insurance contract to the bankruptcy trustee in a Chapter 7 case.
This was borne out in recent rather sad case in Indianapolis. A widower filed Chapter 7 with approx. $13,000 in cash value in a life insurance policy. His wife — the designated beneficiary — had died before he filed bankruptcy. So under the contract his probate estate would be the alternative beneficiary. Even though he had then remarried and (presumably) his new wife would be at least a partial beneficiary of his probate estate, the bankruptcy court concluded that the trustee could take the cash value of the life insurance to pay creditors. See In re Kaufman (SD Indiana 2013)
In my state, Missouri, the policy is protected without regard to beneficiary – but only the first $150,000 of cash value is protected in bankruptcy. So it really does matter where you are and to make sure your bankruptcy lawyer knows the rules.
In most cases, folks don’t build up large cash value in life insurance policies. Or they take/borrow that money out before they consider bankruptcy. But for some folks, the cash value is critical for their planning. They build it up so it can be used to cover the cost of the insurance premiums later in life. And they want to keep these policies in force to provide for their families when they die. (Whether these policies are a good deal for you financially is another issue entirely but that’s a different article.)
So as part of your financial — and bankruptcy — planning, you should make sure your life insurance beneficiary designations are updated to pay out to the right people. Like your spouse, child or other dependent. That’s who you probably wanted to care for if anything happened to you anyway, right?
A quick disclaimer — I am not licensed in Indiana so what I’m reporting here is exactly that — reporting — not legal advice.
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Last modified: February 25, 2013