A 12-part Series On All You Need To Know About The Process of Filing for Chapter 7 Bankruptcy
Part Six – Life Insurance in Bankruptcy
Life insurance is an asset. A life insurance policy that’s still active is unmatured. Term life insurance matures when the policy term ends. Other life insurance typically matures when the insured person dies. Some policies also have maturity clauses. For example, a maturity clause might say that the policy matures either when the insured dies or turns 99 years old, whichever happens first. An interest in an unmatured policy is always a part of your bankruptcy estate, but it doesn’t always affect your estate’s value.
Most term life insurance is not matured, and therefore has no value. Nonetheless, unmatured life insurance is fully exempt. The only time life insurance becomes an issue is when it has matured or if it is a whole insurance policy with cash value.
Let’s talk about life insurance that has matured. If you’re the beneficiary of a life insurance policy and the insured dies, the insurance proceeds you receive will most certainly impact your decision to file bankruptcy. How much of the proceeds you get to keep depends on whether the proceeds are part of your bankruptcy estate and, if so, whether you can claim them as exempt. Nonexempt proceeds can be taken by the trustee to disperse to your creditors.
Under the Bankruptcy Code, the relevant date to determine whether proceeds are part of your estate is the date you become entitled to receive payment. This usually happens upon the insured’s death. If that date is before or within 180 days after the date you file bankruptcy, the insurance proceeds are part of your bankruptcy estate, regardless of when you receive the funds. If you file bankruptcy and you are a beneficiary of a life insurance policy, and that policy matures within 180 days of filing you will have to amend your petition and include those proceeds.
In California proceeds of life insurance are exempt “to the extent reasonably necessary for the support of the judgment debtor and the spouse and dependents of the judgment debtor.” (See California Code of Civil Procedure §704.100). Of course, if you have no real estate and you elect to use the exemptions in California Code of Civil Procedure §703 you can use the wildcard exemption to exempt some or all the proceeds.
Whole life insurance is different because it has cash value. So even if the insured is still alive and the life insurance has not matured the cash value of the life insurance policy will have to be included in the bankruptcy estate. The cash value will be the current cash value minus any amounts borrowed from the life insurance cash value. Under California Code of Civil Procedure §703.140(b)(8) and California Code of Civil Procedure §704.100(b) (depending on which set of exemptions you elect to use) a portion or all the cash value can be exempted depending on the amount. Remember, if you have no real estate and you elect to use the exemptions in California Code of Civil Procedure §703 you can use the wildcard exemption here as well. If you cannot fully exempt the cash value of a whole life insurance policy the trustee will either liquidate the life insurance policy and take the money to disperse to your creditors or you will have to pay the trustee the non-exempt cash value to keep the life insurance.