Bankruptcy & Life Insurance: What to Know
Today’s question comes from Kevin, a long-time resident of Connecticut. Kevin is filing for Chapter 7 bankruptcy and was told by a friend that the bankruptcy trustee will take his life insurance policy. So, let’s go over in detail how term life and whole life insurance policies can affect a bankruptcy case.
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Term Life Insurance
Term life insurance is an insurance policy that lasts for a specific term. This is common in child support cases where the parent must pay child or spousal support. The life insurance policy would last for the years the obligation exists.
For example, if the child is thirteen years old and the child support obligation ends at age eighteen, the term life insurance policy would be for five years.
Term life insurance has no value until the death of the insured person. So when bankruptcy is filed, while there is an expense for life insurance that will be listed on the bankruptcy petition, since it has no value, there are no exemption issues, and it is of no interest to the trustee.
Term Life Insurance as a Beneficiary
If you filed for bankruptcy and are a life insurance policy beneficiary, there is nowhere to list that on the petition. Remember, term life insurance policies have no value until the policyholder’s death.
At the 341 meeting of creditors, the trustee will ask debtors if they are beneficiaries of a life insurance policy. What happens next depends on the answer.
While most people might be beneficiaries of a life insurance policy, the trustee’s follow-up question is, and as morbid as it sounds, is the insured nearing death? The reason is that if so, the bankruptcy estate could have an interest in that policy.
It’s for this reason that’s a standard question that bankruptcy attorneys should ask at the initial consultation. If not, the debtor could risk losing tens of thousands of dollars.
However, if there are no health issues with the policyholder, the bankruptcy case would not be affected as there’s no current or immediate interest in the life insurance policy as the beneficiary.
Whole Life Insurance Policy
A whole life insurance policy is different from a term life policy. The main difference is that a term life policy has no value until the policyholder has died. While a whole life insurance policy has a cash value.
Like the term life insurance policy, if payments are made on a whole life insurance policy, that expense must be listed in the bankruptcy petition.,
The cash value must also be listed on the schedules if you have a whole life insurance policy. The value of the whole life insurance policy could be determined by contacting the insurance company.
Bankruptcy Exemptions
Exemptions protect assets when a debtor files for bankruptcy. Exemptions, or protections as I call them, vary per state.
Once exemptions are applied, any value that exceeds the exemption is not protected. For example, personal property exemptions in Florida are $4,000 if the debtor doesn’t own a home.
Suppose the debtor has $5,000 in personal property and is to receive the proceeds of a life insurance policy valued at $10,000. Between personal property and the life insurance policy, the debtor is $11,000 over the exemption.
The debtor’s option depends on which chapter in bankruptcy was filed.
Chapter 7 versus Chapter 13 Bankruptcy
To determine how the life insurance policy issue would play out in a bankruptcy case, let’s first review the difference between a Chapter 7 and a Chapter 13 bankruptcy.
With Chapter 7, known as a liquidation, any nonexempt assets belong to the bankruptcy estate. Depending on the facts of the case, it is sometimes possible to buy back any interest in nonexempt assets with a short payment plan with the bankruptcy trustee that typically lasts between ten to twelve months.
In the example above, the debtor must pay back the $11,000 in twelve months. The debtor can also surrender the policy proceeds to the bankruptcy trustee, who will distribute the funds to creditors.
Chapter 13 is known as a reorganization and wage earners plan. Chapter 13 bankruptcy requires income since a payment plan lasts three to five years. In this case, the $11,000 is paid back during that thirty-six to sixty-month period.
I hope this blog post helps you understand the difference between life insurance policies and how they could affect a bankruptcy case. If you prefer videos, feel free to visit my YouTube Channel. If you have a question you would like to suggest for the Reader’s Question forum, feel free to contact me.
Colleges and universities can purchase my bankruptcy law textbook directly from Routledge Publishing. Individual copies are available through all major book retailers, including Amazon Books. To subscribe to my YouTube Channel, follow this link.
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Remember that the information on this site should be used for educational purposes only. Always make sure to consult with a local, experienced bankruptcy lawyer.
Updated on March 17, 2025.
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