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Can I Protect Life Insurance Funds in Chapter 7 Bankruptcy?

If You Have Already Received A Life Insurance Benefit Distribution Before Filing …

life insurance funds in chapter 7 bankruptcy

Life Insurance Funds in Chapter 7 Bankruptcy: A Fact-Based Analysis

If you have lost a spouse prior to filing a Chapter 7 bankruptcy, life insurance proceeds you’ve already received may be able to be protected from liquidation if the proceeds can be argued to have been reasonably necessary for your support at the time that they were received—and at the time that you are filing the bankruptcy.

Section 522(d)(11)(C) of the US Bankruptcy Code contains the Federal exemption for life insurance proceeds. Specifically, this provision of the statute states that a Debtor’s right to receive property or property that is traceable to “… a payment under a life insurance contract that insured the life of an individual of whom the debtor was a dependent on the date of such individual’s death, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor …” may be exempted from the legal Bankruptcy Estate from which a Chapter 7 Trustee may liquidate (sell off for the benefit of creditors) assets.

In other words, the plain language of the statute states that the deceased person must have been one upon whom you were a “dependent” on the date of the person’s death—and the property, the insurance proceeds, are exempted only to the extent “reasonably necessary” for your and your own dependents’ “support.” That is, do you need the money to live on? Is it reasonably necessary for your continued living expenses?

Obviously, this is a very fact-based analysis that will vary from person to person. Case-law on this point has swung on the question of how “supplementary” the insurance proceeds are to a debtor’s own income and own ability to meet their necessary, reasonable living-expenses for the rest of their working life. Is the money from the insurance pay-out simply “gravy”—or is it the only or primary source of income the person has, because they are disabled or elderly or suffer some other end-cap to their lifetime earning power?

Expect a Discussion with Your Trustee—Or a Fight

Depending upon the amount of money involved, a Debtor relying on this exemption to protect an amount of cash already received prior to filing from an insurance pay-out can expect to have at least an involved discussion with the Chapter 7 Trustee, if not an outright fight. The proper handling of such property and the proper handling of any such subsequent discussion or litigation with a bankruptcy Trustee is a primary reason why consumers should always retain an experienced bankruptcy attorney when proceeding with a Chapter 7 or Chapter 13 bankruptcy.

Michigan’s own bankruptcy exemptions, which may be utilized instead of the Federal exemptions, also allow for the exemption of life insurance proceeds—but only if  the original policy includes a clause prohibiting proceeds from being used to pay the creditors of the beneficiary, much like a spendthrift clause in a testamentary trust.

In addition, a Chapter 13 bankruptcy is always an option worth exploring if certain assets appear to be difficult to exempt or protect once you sit down to discuss your situation with an experienced Michigan bankruptcy lawyer. In a Chapter 13 bankruptcy, no assets are ever liquidated by the Court. Instead, you repay some of what you owe based on your ability to repay your debts over a period of 3-5 years. You may argue about the size of your monthly plan payment with the Chapter 13 Trustee—but you will never argue about whether you keep your cash.

If you are a Michigan resident and would like to explore your options for a Chapter 7 or Chapter 13 bankruptcy with an experienced Michigan bankruptcy attorney, please contact us at (866) 674-2317 or click the button below to schedule a free, initial consultation.

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