By Richard Farrell
Special to USInsurance.com
Bankruptcy may seem the only way out for many people. It is, however, a decision that requires great care because of the social stigma and consequences that are attached to it. Fortunately, American law protects a certain quantity of a bankrupted person’s assets, under the principle that they should retain enough to rehabilitate themselves, and start again. A related principle is that they should be able to leave an estate large enough to help their families restart too, should they pass away shortly.
These are the rules applying to life insurance in the U.S. in terms of bankruptcy:
• While many citizens believe that Americans who file for bankruptcy stand to lose all their assets (including the value in their life insurance policy) federal law in fact sometimes allows them to keep their homes, and exempts a maximum of $10,775 from their life insurance policies too. This amount is doubled if they are married. This is because the government wants Americans to have life insurance benefits to cover costs and obligations that they may leave behind.
Individual states may opt out of this arrangement and approve their own rules, and every state has applied their own variation on the federal theme. Only Arkansas, Connecticut, District of Columbia, Hawaii, Massachusetts, Michigan, Minnesota, New Hampshire, New Jersey, New Mexico, Pennsylvania, Rhode Island, Texas, Vermont, Washington and Wisconsin still allow the federal alternative – but a bankrupted person may not choose both.
Many states require that a bankrupt person has held a life insurance policy for one or even two years before declaring it exempt. There are limitations on monthly payments too, to discourage policy stuffing before filing. Some states exempt life insurances taken out on spouses or other close family members too, while others do not.
Annuity assets are a related subject because these are often a form of life insurance purchased to protect a family when something unexpected happens. The Employee Retirement Income Security Act of 1974 protects many forms of employer-sponsored retirement plans from creditors. The United States Department of Labor is on record that these assets fall under the protection of individual State creditor-protection legislation, and that the Federal rules may not supersede this. Not all retirement plans come under the umbrella of the Employee Retirement Income Security Act of 1974, and a legal opinion may be necessary.
Annuities taken out on an individual basis do not enjoy a similar level of protection under bankruptcy, and the limited exemptions that apply vary widely from state to state. Florida, New York and Texas protect a portion of any annuity owned by their residents from creditors, although once again the amounts and rules vary.
The rules for the exemption of life insurance policies (and annuities too) from bankruptcy vary widely across America, and there is no simple summary available that cover every eventuality. A person facing the prospect of becoming bankrupt needs specialist advice, to ensure that they secure every dollar that they possibly can to build their future.
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