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Filing for bankruptcy is usually a person’s worst nightmare, but when it comes to protecting your assets (including the value of your life insurance policy), information is key.
A life insurance policy is considered a valuable asset, which means that creditors may attempt to “acquire an interest in the values of the policy”, but all states and the federal government have “enacted legislation providing protections for life insurance against creditor claims,” says Glenn. E. Stevick, Jr., professor at American College.
Here are some basics you should know about bankruptcy and how it affects your life insurance policy.
First of all, more people are declaring bankruptcy than you might imagine. With the latest economic downturn and rising bills, the current rate of filing for bankruptcy is at its highest level in 5 years, according to recent data released by Automated Access to Court Electronic Records (AACER). Additionally, the American Journal of Medicine reported that more than 1.5 million people filed for bankruptcy last year, with 60% of those filings being the direct result of medical bills.
The American Journal of Medicine, for example, found that one in 25 people in the Bay Area filed for bankruptcy last year, said bankruptcy attorney Jeena Cho of the San-based JC Law Group. Francisco.
“It’s like the dirty little secret,” Cho says. “Two things we don’t talk about are death and money. When people start talking about their financial problems, they find that there are a lot of people in the same boat.
There are two types of bankruptcy for individuals: Chapter 7 and Chapter 13.
Chapter 13 is where you can keep your assets and not risk losing property, but you must pay off some of the debt over a period of three to five years. If your cash value for life insurance is worth more than the exemption in your state, consider filing Chapter 13 to protect your assets, recommends Cho.
If you pass a means test and can file for Chapter 7, you must liquidate your property and assets, which usually takes four months. It also means that your life insurance policy could be affected.
Cho says one of the worst things someone can do is liquidate their assets and start borrowing money from their life insurance and retirement funds, which are almost always protected in bankruptcy. .
“People are starting to take what little money they have to see if they could pay off their debts by paying them off,” Cho says. “I see people draining their $40,000 retirement fund for $100,000 in credit card debt. They start selling their cars and houses without an exit strategy. The game plan is to keep as much as possible.
Also, be sure to disclose everything, including the current and exact cash value of your whole life insurance policy. Some people don’t “because they’re scared and end up losing it because they haven’t disclosed its true value,” says David Leibowitz, bankruptcy attorney at Lakelaw in Chicago, Illinois.
Under state and federal bankruptcy laws, a person filing for bankruptcy can elect exemptions under either federal or state law, but not both. Stevick explains, 34 states like Illinois, New York, California and Florida have “excluded” themselves from federal law and instituted their own state protections.
Sixteen “states of choice” – including Texas – allow debtors to choose between federal and state exemptions. Under federal exemptions, one can protect up to $10,775 of the cash value of a life insurance policy (doubled for married couples). Also, in some states, the unused portion of the homestead exemption (real and personal property) can be used for other property, including the cash value of a life insurance policy. Some states require the policy to be in force for one to two years for protection under a state exemption, to avoid using life insurance as a safe haven in bankruptcy planning.
To be eligible to file for bankruptcy under state protections, you must be considered a resident and live in a state for 24 months.
In Illinois, whole life insurance is exempt from creditors to the extent it is necessary to support a dependent (a spouse and dependent children), but the legal interpretation is up to your bankruptcy judge.
When you file your bankruptcy petition, you typically include a schedule or list of your exempt assets, which may include your life insurance policy.
Ron Caruthers, a financial planner who helps individuals pay for college with overfunded life insurance policies, says Florida is the most debtor-friendly state to file for bankruptcy because it has a strong exemption for homesteads. Texas is another debtor-friendly state, which allows significant exemptions for livestock and homesteads.
“That’s why OJ Simpson took all of his assets and moved to Florida and put them in life insurance and a house because they couldn’t touch either when he filed for bankruptcy,” says Caruthers.
On the opposite end of the spectrum is Arizona. Caruthers says Arizona is the most creditor-friendly state.
Keep in mind that all 50 states are different when it comes to bankruptcy protections, so it’s best to contact a financial planner or bankruptcy attorney in that state to learn more.
Here are some suggestions on what to look for before declaring bankruptcy.
Death benefits: How much of the death benefit proceeds are protected from creditors (some states have a dollar amount like $5,000 or $10,000, other states allow the full amount.)
It is important to consider the amount of your life insurance policy that is protected. For example, in California an unmatured policy is exempt up to $11,475 for owners who file jointly or separately under code 704(c), non-owner owners file under 703.140(b) which allows up to 11 $800. Suppose your life insurance policy exceeds $11,475, you can use the generic exemption of $23,250, which can also be applied in part or in whole to the policy.
Check the exemption statistics where you do business, as every state is different. Pay particular attention to the differences between state and federal laws and which parties are protected – the policy owner, beneficiaries, etc.